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In accrual accounting, it is important to organize income properly, especially when it comes to prepaid services. Unearned revenue is a liability and is treated in a very unique way. Unearned revenueSome businesses work by having their customers pay in advance for services, which translates into unearned revenue for those businesses. Unearned revenue is money that is received by a business before goods or services are provided. Since prepaid revenue is a liability for the business, its initial entry is a credit to an unearned revenue account and a debit to the cash account. On a balance sheet, the “assets” side must always equal the “equity plus liabilities” side.
Cash on the balance sheet would increase by $60, and a liability called unearned revenue would be created for $60 to offset it. The expenses will be divided up and reported in the same period. So $100 will come out of the revenue account and you will credit your expense account $100. It is important to perform these adjusting what is unearned revenue entries to recognize deferred revenue according to the contract set in place. Unearned revenue—also called deferred revenue—is money a company has received in advance for goods or services not yet been delivered or performed. Unearned revenue is a common type of accounting issue, particularly in service-based industries.
How to Calculate Unearned Revenue
It looks like you just follow the rules and all of the numbers come out 100 percent correct on all financial statements. Some companies do this by recording revenue before they should. Others leave assets on the books instead of expensing them when they should to decrease total expenses and increase profit. With an adjusting entry, the amount of change occurring during the period is recorded. Similarly for unearned revenues, the company would record how much of the revenue was earned during the period. Unearned revenue and deferred revenue are synonymous terms.
Unearned revenue is recognized and converted into earned revenue as products and services get delivered to the customer. Companies that use the accrual method of accounting are required to record unearned revenue. This is a particularly important requirement for any large publicly-traded company.
Accruals and prepayment: Unearned revenue explained
It is a pre-payment on goods to be delivered or services provided. FreshBooks has online accounting software for small businesses that makes it easy to generate balance sheets and view your unearned revenue. It would go in the “liabilities” category, as it is money owing. The business has not yet performed the service or sent the products paid for.
- It can be thought of as a “prepayment” for goods or services that a person or company is expected to supply to the purchaser at a later date.
- Once the goods or services have been delivered or performed, the liability is extinguished and the revenue is recognized.
- If revenue gets posted to the income statement too early, it can overstate actual sales revenue.
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- When you receive unearned revenue, you will record it on your business balance sheet first and then make the journal entry.
The customer pays $50 up front for the full year of service. This would initially be marked as unearned service revenue because the company has received a full payment for services not yet provided. The full $50 would need to be recorded as unearned service revenue on the company’s balance sheet. As each month of the annual subscription goes by, the monthly portion of this total can be deducted and recorded as revenue.