What is Unearned Revenue?
Unearned revenue is amount of money that is received by the business for goods and services that is yet to be delivered or rendered. Unearned revenue can also be interpreted as revenue received in advance from customers but the performance of service or delivery of goods would be done later on.
Hence, the business creates the liability in its balance sheet till goods or services are delivered or performed. Popularly, unearned revenues are also known as deferred revenue or advance payments.
Some business models regularly thrive on the basis of unearned revenue. These are businesses selling subscription-based products and which would require advance payments. Popular examples include, rent payments are made in advance, prepaid insurance, airline tickets payments, newspaper subscriptions and payments for the use of software.
Receiving money in advance is very beneficial for the business to thrive. The revenue received early can be used in various ways like prepayment of debt or making requisitions of more inventory.
Recognition of unearned revenue
Unearned revenues provide various clues into how the company would be able to generate revenue in the coming quarters of reporting. The figure of unearned revenue becomes great importance to investors. Netflix is based on subscription model. The coronavirus although resulted in spurge of demand for Netflix.
Not every business has been spared. Take for example football sports club. They usually allow for annual subscription to fans to watch all the games. Manchester United for example would have to refund all the yearly fees it received from football fans for annual ticket membership fees.
This is meant to say things can go both ways in case of unearned revenue. The business may have to refund the unearned revenue in case of adverse circumstances.
There are three ways to record revenue. In case of accrual revenue, revenues are recognized at the time of performance of work. This is the general approach to record revenue and is in line with accounting principles. In case of deferred revenue, which equates to unearned revenue, the cash is received before the revenue has to be recognized as per accrual system of book keeping. T
his approach considers unearned revenue as a liability until the goods or services are delivered or rendered as the case may and then the revenue shall be identified. Another common transaction is when the business receives cash at the same time the goods or services are provided. In that case, revenue will be recorded impromptu.
How Unearned Revenue is Reported?
Unearned revenue is promised service that has not been performed. Hence, such revenue which is technically not a revenue has to be reported. There are two methods to report unearned revenue. These are liability method and income method.
In case of liability method, the unearned revenue is considered as liability. The appropriate reason for this would be that company has not performed the service and hence, the work seems to be pending even though the cash seems to have been received.
Hence, the unearned revenue has to be reported as a liability. At the end of March, the company will make adjusting entry which looks as
Unearned Revenue and How It Is Accounted for in Business
The journal entries would look as :
|Date||Particulars||Debit ($)||Credit ($)|
|(To record cash received in advance from customer)|
|(To record revenue for the services performed)|
The same payment of unearned revenue would be treated differently if the company uses income method. The income method approaches towards the unearned revenue as advanced payment as income. The general trade practice is however liability method.
Unearned Revenue in Balance Sheet
The customers do advance payments for the services they expect to be performed within a few months or a year at stretch. Hence, unearned revenue would be recorded under short term liabilities alongside trade payables. This would be reported under the Liabilities side of Balance sheet. Let’s take a short example.
Sinra Inc has received internet subscription for 3-month package from 200 customers at $ 30 dollar per customer per month in the first week of April for April to June package.
Now, in the first week, Sinra Inc has to recognize all of 200 customers as unearned revenue. This would be 200*30*3 = $ 18000
If the balance sheet is made at the end of April month i.e. at April 30, it would look as the following :
|Assets||$||Liabilities and stockholders’ equity||$|
|Current Assets||Current Liabilities|
|Unearned Revenue X Less: recognized as revenue (X)||XXX|
|Non-Current Assets||Non-current Liabilities||XXX|
|Total Assets||XXX||Total Liabilities and Stockholders’ equity|