There are many things to keep track of as a business accountant. Not only should you track revenue a company has, but you may be called upon to record unearned revenue. What is unearned revenue? How do you keep track of it? Our guide to unearned revenue accounting will answer these questions.
What is Unearned Revenue and When Does it Occur?
Unearned revenue is sometimes called deferred revenue. It refers to prepayments received by a company or supplier from customers who ordered goods and services to be delivered later.
Companies and suppliers that record these prepayments register a liability equal to the prepayment until they deliver the goods and services in question. The revenue is essentially a debt owed to the customer until the promised goods and services are provided.
Individual suppliers and companies typically record unearned revenue as a liability on the balance sheet. The money becomes company revenue after the goods and services are delivered. The cash is mode from being a liability to being a net gain for the business.
Unearned Revenue Examples
Now we know the unearned revenue definition, let’s look at some examples. Unearned revenue is common with companies and suppliers that use subscription models and products or other services that use prepayments.
Some unearned revenue examples include paying rent in advance, buying airline tickets, newspaper and publishing subscriptions, prepaid insurance, and software licenses. Things like gym memberships, Netflix subscriptions, and the like are excellent examples of unearned revenue.
What Is Unearned Revenue on a Balance Sheet?
The question of how to record unearned revenue on the balance sheet is almost as important as the question of what is unearned revenue itself. Unearned income is listed as a liability on company balance sheets. The money is considered a liability because the company hasn’t earned money yet. Instead, it represents products and services owed to customers. Given that prepaid services and products are delivered over time, it is listed as revenue for income statements.
Let’s use Amazon Prime as an example. Gary is a regular user of Amazon and buys something every other week or so. He learns that Amazon offers Amazon Prime, which is perfect for someone like him. Gary wants access to the free shipping and music streaming he would get and pays the $79 subscription.
Amazon would class the money as unearned revenue because they get the full payment before delivering Gary the services he paid for with his account. Amazon registers the money as unearned revenue on its balance sheet. We’ll get more into unearned revenue accounting in a minute.
At the end of each month, the monthly portion of the total amount (which is 75/12 = 6.58) is deducted from the unearned revenue column and recorded as earned revenue. The process repeats until the end of the subscription period, when the last portion of the payment is recognized as company revenue.
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.
What Is the Journal Entry for Unearned Revenue?
Companies can take one of two approaches with unearned revenue accounting. These approaches are called the Income Method and the Liability method, and both offer ways to record journal entries for unearned income.
As well as being two methods to record unearned transactions, the two ways have two distinct differences between them – when the entries register the receipt date and recognize revenue from the transaction.
On top of this, when goods and services are delivered simultaneously over extended periods, the proportion of revenue from the purchase is recognized as a result of the proportion of services rendered or goods provided.
Accountants can adequately account for all of this by sticking to a schedule. Accountants should properly track the completion of projects and services to recognize revenue according to local guidelines accurately. Different countries have regulations for tracking unearned income. Make sure that you understand how to stay compliant with your local authority.
With all that out of the way, let’s look at the Liability Method and Income Method.
- Liability Method
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.
For example, if someone paid a company $50 for a years’ worth of magazines, the full payment is considered a liability until the end of the year.
- Income Method
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. 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.
To summarize, unearned revenue refers to money that a company receives ahead of time. It accounts for things like subscriptions and prepayments. 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.