What Is Unearned Revenue and How to Account for It

As each of the premium service elements are implemented, additional entries are made by the bookkeeper to indicate that services have been provided to the client. For example, once the new staff is hired and trained, a $2,000 debit entry to unearned revenue is entered and a $2,000 credit entry to cash is entered.

The monthly entry for $2,000 is often described as a deferral adjusting entry. Financial Accounting Standards Board , require companies to record prepayments as unearned revenue. Cash basis accounting is an accounting system that recognizes cash when received and bills when paid. Accrual basis accounting is an accounting system that recognizes revenue when it is earned and expenses when bills are received, regardless of when cash actually changes hands. Unearned revenue is also referred to as deferred revenue and advance payments.

Example of Unearned Revenue

Learn the definition of unearned revenue and how to calculate unearned revenue with the help of relevant examples. Financial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period . Shareholders Equity SectionShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders’ Equity Statement on the balance sheet details the change in the value of shareholder’s equity from the beginning to the end of an accounting period. Since the actual goods or services haven’t yet been provided, they are considered liabilities, according to Accountingverse. The credit and debit are the same amount, as is standard in double-entry bookkeeping. As each month of the annual subscription goes by, the monthly portion of this total can be deducted and recorded as revenue.

• Under the accrual basis of accounting, recording deferred revenues and expenses can help match income and expenses to when they are earned or incurred.
• The two entities created the ASC 606–a 5-step model for recognizing unearned revenue.
• It is a liability because even though a company has received payment from the customer, the money is potentially refundable and thus not yet recognized as revenue.
• If a transaction doesn’t go through, the organization may have to use the money it needs to raise more funds.
• All of the metrics you need to grow your subscription business, end-to-end.

ASC 606 is especially impactful for companies that sell services rather than goods. The 5-step model details how sellers of subscriptions and licenses are supposed to recognize their revenue when a customer prepays.

What Is Revenue? Definition and Formula

For unearned revenues, the company received the payment from its customers before goods or services are provided to the customers. Unearned Revenue Is A LiabilityUnearned revenue refers to the advance payment amount received by the company against goods or services pending for delivery or provision respectively. You report unearned revenue on your business’ balance sheet, a significant financial statement you can generate with accounting What Is Unearned Revenue: Definition and Examples software. You record it under short-term liabilities (or long-term liabilities where applicable). Since it is a cash increase for your business, you will debit the cash entry and credit unearned revenue. Where unearned revenue on the balance sheet is not a line item, you will credit liabilities. You can only recognize unearned revenue in financial accounting after delivering a service or product and receiving payment.

In cases like insurance and subscriptions, the revenue is recognized on a monthly basis. So, using our XYZ Company insurance example, https://business-accounting.net/ let’s say you sell a 12-month policy for $1,200 and receive the money January 1st; the policy takes effect on January 1st.