Unearned Revenue: What It Is, How It Is Recorded and Reported

Before we understand what unearned revenue is, we must fully understand what revenue is. Then we can look at the difference, how it is treated in financial reports, and what it means for an organization’s ability to increase its competitive advantage. Accounts receivable are those receiving the goods or services before paying for them. Unearned amounts are when the customer pays before they receive the service or goods from the organization. When the organization earns the revenue, additional adjusting journal entries must be made compared to when the revenue is earned upon payment.

• As a simple example, imagine you were contracted to paint the four walls of a building.
• In this article, I am going to go over the ins and outs of unearned revenue, when you should recognize revenue, and why it is a liability.
• When customers pay in advance, the company records this as unearned revenue on the balance sheet.
• Revenue is only reported when the service or good is provided and the money is paid for.
• Baremetrics integrates directly with your payment processor, so information about your customers is automatically piped into the Baremetrics dashboards.
• Unearned revenue, sometimes called deferred revenue, is when you receive payment now for services that you will provide at some point in the future.

Unearned revenue sometimes referred to as deferred revenue is the payment received in advance for the products or services that will be delivered at some point in the future. Unearned revenue is recorded on the liabilities side of the balance sheet since the company collected cash payments upfront and thus has unfulfilled obligations to their customers as a result. According to the revenue recognition principle established unearned revenue under accrual accounting, a company is not allowed to recognize revenue on its income statement until the product or service is delivered to the customer. Some examples of unearned revenue include advance rent payments, annual subscriptions for a software license, and prepaid insurance. The recognition of deferred revenue is quite common for insurance companies and software as a service (SaaS) companies.

Unearned Revenue: What It Is, How It Is Recorded and Reported

These ratios can be benchmarked to compare the organization’s performance to their competitors and industry average. This can be anything from a 30-year mortgage on an office building to the bills you need to pay in the next 30 days. As a simple example, https://www.bookstime.com/ imagine you were contracted to paint the four walls of a building. Get deep insights into your company’s MRR, churn and other vital metrics for your SaaS business. This way, they can accurately reflect the true financial data of their business.

Unearned revenue is based on accrual accounting, in which the revenue is recognized only when the products or services are delivered to the customer, not even if the payment for those services is received in advance. While unearned revenue refers to the early collection of customer payments, accounts receivable is recorded when the company has already delivered products/services to a customer that paid on credit. Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered. 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. As a result of this prepayment, the seller has a liability equal to the revenue earned until the good or service is delivered. This liability is noted under current liabilities, as it is expected to be settled within a year.

Income statement

Overstating the revenue will also overstate the tax obligation of the organization and will lead to them paying more money than they need to. An unearned sum is a way for the organization to distinguish between the revenue they have earned and thus must make tax payments on and the money they have not yet earned and do not need to make tax payments on. The revenue that the organization makes is put into the income statement. The organization must pay taxes on the revenue after subtracting expenses multiplied by the tax rate. Then, on February 28th, when you receive the cash, you credit accounts receivable to decrease its value while debiting the cash account to show that you have received the cash.

If the company fails to deliver the services or products to the customer or the contract is finished between both parties, the company will have to pay the money back to the customer. It’s important to track and monitor this data over time to ensure that the cash flow statement properly reflects financial performance. This press release contains “forward-looking statements” that are subject to substantial risks and uncertainties. All statements, other than statements of historical fact, contained in this press release are forward-looking statements. For the twelve months ended September 30, 2022 and 2023, this amount relates to property included in “Principal repayments of finance leases” of $8,561 million and $5,245 million. From the date of initial payment, the payment is recorded as revenue on a monthly basis until the entirety of the promised benefits is confirmed to have been received by the customer.

Unearned revenue in the cash accounting system

The recognition of unearned revenue relates to the early collection of cash payments from customers. This adjustment changes the value from liability on the statement of financial positions on the organization’s reports to the income statement of the organization’s reports. Conversely, if you have received revenue from a client but not yet earned it, then you record the unearned revenue in the deferred revenue journal, which is a liability. 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). When one month passes, the company will reclassify the current liability to revenue earned. This is because The website owners have now completed the obligation of providing a one-month music service to the customer.

As time passes and you use hosting each month, your hosting provider will gradually recognize revenue on its income statement and reduces liabilities accordingly. The liabilities section of the balance sheet will record the amount of unearned revenue that has been paid upfront by customers but not yet delivered or services provided. Every month the gym will make an entry to recognize the revenue from your membership. This will be a decrease in unearned revenue (liability) and increase in earned revenue (income). They will continue to recognize the $100 every month until you have “used up” your pre-paid membership. Over time, the revenue is recognized once the product/service is delivered (and the deferred revenue liability account declines as the revenue is recognized).

Sometimes you are paid for goods or services before you provide those services to your customer. If an issue arises with unearned revenue, it’s important to research and rectify the reports. Follow GAAP rules, consult with your audit team, create any necessary unearned revenue journal entry for correction, and issue updated versions of any impacted financial reports. Unearned revenue is recorded on the balance sheet as a liability/liabilities, since it corresponds to an obligation that has yet to be fulfilled by the business. The financial concept  is essential in accrual accounting, where revenue recognition is not solely based on the exchange of cash but on the fulfillment of the company’s obligation to its customer.

It also means that the equipment and planning that went into the transaction must be discarded, and with unearned revenue, the chances of this are higher than earned revenue. One of the limitations is that the money does not belong to the organization. That is why it is stated as a current liability in the statement of financial position for the organization and must be credited when adjusted. This decreases the number of bad debts as the money is already paid by the customer. Therefore, it allows the organization to be more efficient with its inventory and the time it takes to perform services. It must be a skill learned by those preparing the organization’s financial reports, as negative repercussions can occur if they are not placed in the right accounts.

In this guide, we go over exactly what you need to know about reporting unearned revenue. Why then does your pre-paid membership create a liability for the company? If the gym burned down in May and you could no longer go to the gym, the company would be “liable” to you for the remaining 7 months of membership dues that you paid for but did not get to use. More specifically, the seller (i.e. the company) is the party with the unmet obligation instead of the buyer (i.e. the customer that already issued the cash payment). Unearned revenue is treated as a liability on the balance sheet because the transaction is incomplete. The more cash on hand, the better for the organization, as it will increase its quick ratio.

If the service is eventually delivered to the customer, the revenue can now be recognized and the following journal entries would be seen on the general ledger. Initially, the total amount of cash proceeds received is not allowed to be recorded as revenue, despite the cash being in the possession of the company. This allows the organization to focus on other aspects of the business, and they also don’t need to worry as much about bad debts if more of their customers start prepaying the money for the goods and services. When they pay the rest and complete the transaction, they need to adjust the accounts. They do this by adjusting the half that was paid before the goods and services were provided and adjusting them to revenue.

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Their representation in these three forms changes as revenue moves into and out of the company and shifts from deferred to recognized status. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. When this happens, sometimes the transaction is recorded differently, resulting in the revenue being overstated and liabilities being understated. Many different types of revenue are earned, but they come down to three main types.