Unearned Revenue: Definition and How to Record It

However, if the unearned is not expected to be realized as actual sales, then it can be reported as a long-term liability. For most companies, revenues come as a result of selling products or services. However, sometimes companies may also transfer goods and not receive funds for it but still need to record their revenue. On the other hand, companies may receive money even if they haven’t transferred goods yet.

• Most accounting software allows you to create an unearned revenue account and record transactions accordingly.
• When the business provides the good or service, the unearned revenue account is decreased with a debit and the revenue account is increased with a credit.
• It is recorded as a liability because the company still has an outstanding obligation to provide these goods or services.
• Insurance premiums are often paid in advance for coverage over a specific period.
• As an example, we note that Salesforce.com reports unearned revenue as a liability (current liabilities).

The amount received would be recorded as boo’s unearned income (current liability). Subsequently, unearned revenue liability would decrease, and revenue would be recognized monthly. The accounting entry for unearned revenue is to debit the cash account and credit the unearned revenue account when the payment is received. As goods or services are delivered, the unearned revenue account is debited, and the revenue account is credited.

• Properly managing unearned revenue is crucial for industries such as software or subscription-based services where prepayments are the norm.
• For simplicity, in all scenarios, you charge a monthly subscription fee of $25 for clients to use your SaaS product.
• Subscription-based businesses, service providers, and companies handling pre-orders update their unearned revenue accounts monthly, quarterly, or as obligations are met.
• Careful management of unearned revenue is essential for accurate financial reporting, cash flow management, and meeting customer obligations.

Income Statement Correlations

A similar situation occurs if cash is received from a customer in advance of the services being provided. This is more fully explained in our revenue received in advance journal entry example. Under the accrual basis of accounting, revenues should be recognized in the period they are earned, regardless of when the payment is received. Rent payments received in advance are considered unearned revenue until the rental period passes. Deferred revenue is a broader term that encompasses unearned revenue and other types of revenue that are received in advance but have not yet been recognised on the income statement.

Until the company fulfils its obligation, the payment remains a liability. Unearned revenue and earned revenue represent two different stages in the revenue recognition process. Unearned revenue is money received before delivering a product or service, while earned revenue reflects income from completed obligations. This type of revenue is common in subscription-based businesses, SaaS companies, insurance providers, and prepaid service contracts. Businesses must follow proper financial accounting rules to record and recognize it correctly.

Financial Analysis and Transparency

However, in each accounting period, you will transfer part of the unearned revenue account into the revenue account as you fulfill that part of the contract. This journal entry reflects the fact that the business has an influx of cash but that cash has been earned on credit. Unearned revenue is originally entered in the books as a debit to the cash account and a credit to the unearned revenue account.

This liability is noted under current liabilities, as it is expected to be settled within a year. As an example, we note that Salesforce.com reports unearned revenue as a liability (current liabilities). Unearned revenue can provide insights into future revenue and help with financial forecasting. However, it’s important to analyse both earned and unearned revenue to get a complete picture of a company’s profitability and financial health. Online retailers may receive advance payments for pre-ordered products that have not been shipped yet.

Definition and Examples

Therefore, the accounting treatment for the transaction will be as follows. In some industries, the unearned revenue comprises a large portion of total current liabilities of the entity. For example in air line industry, this liability arisen from tickets issued for future flights consists of almost 50% of total current liabilities. For example, suppose a business provides equipment maintenance services and invoices customers 6,000 annually in advance. When the invoice is issued, no maintenance cover has been provided and therefore the revenue of 6,000 is unearned and a journal entry is required.

Double Entry Bookkeeping

This action increases the cash account and creates a liability in the unearned revenue account. As the product or service is fulfilled, the unearned revenue account is decreased, and the revenue account is increased. Proper cash management is crucial for a company dealing with unearned revenue. Unearned revenue, also known as deferred revenue or prepaid revenue, is money received by a company for a service or product that has yet to be provided or delivered. This type of revenue is recorded as a liability because the company owes the delivery of goods or services to its customers.

This is also a violation of the matching principle, since revenues are being recognized at once, while related expenses are not being recognized until later periods. Until you “pay them back” in the form of the services owed, unearned revenue is listed as a liability to show that you have not yet provided the services. For example, a law firm may charge a $10,000 retainer for legal representation.

For example, a car manufacturer may accept a $5,000 deposit for a custom vehicle that will take six months to produce. The company receives the cash immediately, but the car hasn’t been delivered, so the payment is recorded as unearned revenue. Once the car is built and handed over, the company can recognize the $5,000 as earned revenue. And so, unearned revenue should not be included as income yet; rather, it is recorded as a liability. This liability represents an obligation of the company to render services or deliver goods in the future.

Step 3: Adjust financial statements at the end of each period

Your business needs to record unearned revenue to account for the money it’s received but not yet earned. Recording unearned revenue is important unearned revenue accounting because your company can’t account for it until you’ve provided your products or services to a paying customer. Unearned revenue is a liability for the recipient of the payment, so the initial entry is a debit to the cash account and a credit to the unearned revenue account.

To stay compliant, entities must record unearned revenue as a liability on the balance sheet. This is done because the company has received payment for a product or service which has not yet been delivered or performed. The liability is reduced as the company fulfills its obligations, and the revenue is recognized in the income statement. Unearned revenue is recorded on a company’s balance sheet as a liability.

For example, after three months, the company would have recognized $3,000 in revenue and still hold $9,000 in unearned revenue. These adjustments ensure financial statements accurately represent the company’s revenue and obligations. When a customer pays for a monthly or annual subscription, the business receives the payment upfront but hasn’t yet provided the full service. For example, if a customer purchases a one-year Netflix plan for $120, Netflix can’t recognize the entire $120 as revenue immediately.

Retailers also use prepayments for high-demand items, such as new smartphones, gaming consoles, and luxury goods. This model helps companies predict demand, manage supply chains, and secure funds before production is complete. In effect, we are transferring $20,000, one-third of $60,000, from the Unearned Rent Income (a liability) to Rent Income (an income account) since that portion has already been earned. Insurance premiums are often paid in advance for coverage over a specific period. Baremetrics integrates directly with your payment processor, so information about your customers is automatically piped into the Baremetrics dashboards.

Classic examples include rent payments made in advance, prepaid insurance, legal retainers, airline tickets, prepayment for newspaper subscriptions, and annual prepayment for the use of software. Revenue is only included in the income statement when it has been earned by a business. By making this journal entry, the company recognizes $6,000 of the prepayment as earned revenue and decreases the unearned revenue account by the same amount.