Unearned revenue is the money received by an individual or a company for services that have yet to be provided, or goods that are yet to be delivered. This is a prepayment from the buyer for goods and services to be supplied at a later date.
This would count as a liability for the seller, as the revenue has yet to be earned because the good or service hasn’t been delivered. It is recorded as a liability on a company’s balance sheet.
Companies that have subscription-based products or services have to record unearned revenue. Receiving prepayments can be beneficial for a company that has to purchase inventory or pay interest on the debt.
Some examples of unearned revenue are rent payments, prepaid insurance, airline tickets, gift cards, and subscriptions for channels or newspapers.
When the company provides a good or service and hence “earns” the revenue, they debit the unearned revenue account to reduce its balance and credit the revenue account to increase its balance. The unearned revenue is usually a current liability.
If a company didn’t classify the unearned revenue as a liability and instead recognized it as profit or revenue, it would overstate the profit in the income statement and when the service or good is actually provided, the profits would be understated for that time period.
This goes against the matching principle since revenues are being recognized without the related expenses being recognized.
Unearned income is the income received from investments or other sources that are unrelated to employment. Unearned income is income that is not gained through employment, work, or business activities; hence it is different from earned income.
Earned income includes wages, salaries, tips, and self-employment income. Before retirement, unearned income can be an addition to earned income but after retirement, it is often the only source of income.
Taxation is different for earned and unearned income both.
Interest and dividends are the most common types of unearned income. Interest income earned on savings deposit accounts and loans is taxed as ordinary income. Dividends are income from investments and are taxed at ordinary rates or preferred long-term capital gains tax rates.
Some of the common sources of unearned income are the following:
- Professional fees earned by an individual or commercial enterprise.
- Tips earned in the services sector
- Wages earned on the job
- Self-employment income, which is recorded tax-wise, on an IRS 1099 form.
- Commissions earned on the job, usually in the sales sector.
- Bonuses earned on the job, like a Wall Street broker earns for meeting or exceeding company sales/revenue expectations, for example.
- Sick leave on the job (yes, getting the flu has a financial impact, according to the IRS.
- Personal time-off pay is taken by employees.
- Long-term disability benefits again garnered from full or part-time employment.
- Meal, transportation, and accommodation reimbursement from employees traveling on the company dime.
- Non-cash income earned on the job, such as a vehicle provided to a traveling salesperson by his or her company.
Unearned revenue is a liability for companies and individuals whereas unearned income serves as a supplement to normal earned income for companies and individuals.