What is Unearned Revenue, and Is It a Liability?

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When the three-month period ends, there would be no unearned revenue pertaining to this transaction. This implies that all the revenue that was previously received profit and loss questions in the form of customer advances recorded as unearned revenue would be zero. All the amount would have been recognized and subsequently recorded as revenue.

Unearned Revenue Reporting Requirements

Generally, unearned revenues are classified as short-term liabilities because the obligation is typically fulfilled within a period of less than a year. However, in some cases, when the delivery of the goods or services may take more than a year, the respective unearned revenue may be recognized as a long-term liability. Under the accrual basis, revenues should only be recognized when they are earned, regardless of when the payment is received. Hence, the company should not recognize revenue for the goods or services that they have not provided yet even though the payment has already been received in advance. Under the income method, the entire amount received in advance is recorded as income.

Because the goods and services aren’t delivered all at once, the money isn’t registered as revenue. Accountants adjust the amount over time to recognize when part of the cash becomes revenue per when goods and services are rendered. Companies generally disclose unearned revenue as a current liability on their balance sheet. The unearned income on the balance sheet changes over time as the goods and services are delivered. Goods and services delivered over an extended period of time are classified as long-term liabilities on a balance sheet. At the end every accounting period, unearned revenues must be checked and adjusted if necessary.

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This journal entry should be recorded monthly until the revenue for the entire year has been properly recognized. If your customer pays you a year in advance for your editing services, you can only recognize the revenue for the month in which goods and services have been provided. The journal entries mentioned earlier depict the debit to the bank account to reflect the receipt of funds.

The balance of the money paid early will remain in the unearned revenue account and should only be recognized as the goods and services are provided each month. Not only should you track revenue a company has, but you may be called upon to record unearned revenue. If you provide subscriptions or services, you or your bookkeeper will likely be recording unearned revenue on a regular basis. In addition, property management companies, insurance companies, and other companies that require an advance payment frequently need to record unearned revenue. Hence, as per the accrual concept, revenue is going to be recorded as they are earned by the company.

Terms Similar to Unearned Revenue

Unearned revenue is recorded on a company’s balance sheet as a liability. It is treated as a liability because the revenue has still not been earned and represents products or services owed to a customer. As the prepaid service or product is gradually delivered over time, it is recognized as revenue on the income statement.

• If a portion remains unearned at the end of the accounting period, it is converted into a liability.
• Initially, the insurance company records this transaction by increasing an asset account (cash) with a debit and by increasing a liability account (unearned revenue) with a credit.
• The related account for advance payment that they received should be recognized as a liability in the balance sheet; no revenue should be recorded in the income statement yet.
• On 30 December 2018, ABC Co. received $1,000 as a payment in advance from its client for a consulting service that it will provide from 02 Jan 2019 to 08 Jan 2019.

If you are having a hard time understanding this topic, I suggest you go over and study the lesson again. Preparing adjusting entries is one of the most challenging (but important) topics for beginners. The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent.

When is income or revenue earned?

The funds should be considered a liability and recorded as such until those goods and services are delivered upon. Companies can either record revenue in chunks as time passes or account for the entire payment at the end of the payment period. It is up to individual suppliers and companies to choose the accounting method that works for them.

The liability method sees an accountant make the first entry when the company receives the payment in advance and when that income is entered into the unearned revenue account. The money is recognized as revenue when the goods and services are delivered to the customer. Everything is considered a liability until the end of the payment period. To summarize, unearned revenue refers to money that a company receives ahead of time.

It can be defined as a payment that the company receives against goods and services that are not yet delivered. Note that when the delivery of goods or services is complete, the revenue recognized previously as a liability is recorded as revenue (i.e., the unearned revenue is then earned). Accountants can adequately account for all of this by sticking to a schedule.

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It is common for an electric utility to provide electricity to customers for up to one month before it reads the customers’ meters, calculates the bills and records the billings as revenues and accounts receivable. As a result, the electric utility will have up to one month of expenses (cost of fuel and other operating expenses) without the related revenue being reported. Therefore, at each balance sheet date, the utility must accrue for the revenues it earned but had not yet recorded. This is done through an accurual adjusting entry that debits a balance sheet receivable account and credits an income statement revenue account. The income method is what we’ve been referring to for most of this article. The first journal entry for the Income Methods records when a company receives the payment in its revenue account.

• Ask a question about your financial situation providing as much detail as possible.
• Advance customer payments for newspaper subscriptions or extended warranties are unearned revenues at the time of sale.
• The unearned income on the balance sheet changes over time as the goods and services are delivered.
• On 1st December 2019, they launched an offer under which customers were supposed to pay upfront for 3 months, as a result of which the service charges were to be waived by the company.

However, if a customer prepays for orders that are supposed to be fulfilled for a period of more than 12 months, it is then classified as a long-term liability. In accordance with the accrual principle of accounting, companies are required to record revenues that have been earned, https://online-accounting.net/ and expenses that have been incurred. In other words, only revenues and expenses relevant to the current year are supposed to be included in the financial statements for the given year. It’s always great to be paid in advance for goods and services yet to be delivered.

The adjusting entry for unearned revenue will depend upon the original journal entry, whether it was recorded using the liability method or income method. 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. It will be recognized as income only when the goods or services have been delivered or rendered. The related account for advance payment that they received should be recognized as a liability in the balance sheet; no revenue should be recorded in the income statement yet.

The adjusting entry for unearned revenue depends upon the journal entry made when it was initially recorded. 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. As a company earns the revenue, it reduces the balance in the unearned revenue account (with a debit) and increases the balance in the revenue account (with a credit). The unearned revenue account is usually classified as a current liability on the balance sheet. Suppose a customer pays $1,800 for an insurance policy to protect her delivery vehicles for six months.