Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy. Retailers also use prepayments for high-demand items, such as new smartphones, gaming consoles, and luxury goods.

Is Unearned Revenue a Liability?

Creating and adjusting journal entries for unearned revenue will be easier if your business uses the accrual accounting method, of which the revenue recognition principle is a cornerstone. Businesses accept unearned revenue because upfront payments provide financial stability and reduce risk. Customers often pay in advance for products or services to secure availability, lock in pricing, or meet contract terms.

Module 4: Financial Statements of Business Organizations

Under the accrual basis of accounting, revenues should be recognized in the period they are earned, regardless of when the payment is received. According to the accounting reporting principles, unearned revenue must be recorded as a liability. At the end of the month, the owner debits unearned revenue $400 and credits revenue $400.

How do you record unearned revenue journal entries in accounting?

The adjusting entry for unearned revenue will depend upon the original journal entry, whether it was recorded using the liability method or income method. Unearned revenue is most common among companies selling subscription-based products or other services that require prepayments. Classic examples include rent payments made in advance, prepaid insurance, legal retainers, airline tickets, prepayment for newspaper subscriptions, and annual prepayment for the use of software. 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. By making this journal entry, the company recognizes $6,000 of the prepayment as earned revenue and decreases the unearned revenue account by the same amount.

This model helps companies predict demand, manage supply chains, and secure funds before production is complete. 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. Insurance premiums are often paid in advance for coverage over a specific period. Unrecorded revenue on the other hand, as the name suggests, is not reported during the year. Baremetrics integrates directly with your payment processor, so information about your customers is automatically piped into the Baremetrics dashboards.

Public companies must follow GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards) to ensure accurate revenue recognition. Unearned revenue can provide insights into future revenue and help with financial forecasting. However, it’s important to analyse both earned and unearned revenue to get a complete picture of a company’s profitability and financial health. Rent payments received in advance are considered unearned revenue until the rental period passes. 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).

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. 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 vs Deferred Revenue

A business will need to record unearned revenue in its accounting journals and balance sheet when a customer has paid in advance for a good or service which they have not yet delivered. Once it’s been provided to the customer, unearned revenue is recorded and then changed to normal revenue within a business’s accounting books. Whether it’s a retainer for a lawyer, a deposit on a new car, or a prepaid gym membership, these advance payments give businesses financial security while creating an obligation to fulfill. Companies across industries, from retail and software to professional services, handle unearned revenue daily. Unearned or deferred revenue or advance payments refer to the money a company receives from customers before it has earned it.

Unearned revenue is money received before delivering a product or service, while earned revenue reflects income from completed obligations. 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.

Unearned revenue is an essential concept in accounting, as it impacts the financial statements of businesses that deal with prepayments, subscriptions, or other advances from customers. 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. Proper cash management is crucial for a company dealing with unearned revenue. Unearned revenue, also known as deferred revenue or prepaid revenue, is money received by a company for a service or product that has yet to be provided or delivered.

• The unearned revenue account declines, with the coinciding entry consisting of the increase in revenue.
• Businesses handling large volumes of unearned revenue need efficient tracking and recognition methods.
• These adjustments ensure financial statements accurately represent the company’s revenue and obligations.
• Unearned revenue is the income received by an individual or an organization for a product or service that is yet to be delivered.

Unearned revenue does not initially appear on a company’s income statement. As the company fulfills its obligation to provide the goods or services, the unearned revenue liability is decreased, and the revenue is recognized on the income statement. Unearned revenue plays a crucial role in accrual accounting, as it represents cash received from customers for services or products that have not yet been delivered. It is recorded as a liability because the company still has an outstanding obligation to provide these goods or services.

• Unearned revenue, sometimes referred to as deferred revenue, is payment received by a company from a customer for products or services that will be delivered at some point in the future.
• To do this, the company debits the cash account and credits the unearned revenue account.
• The company can make the unearned revenue journal entry by debiting the cash account and crediting the unearned revenue account.
• Other names used for this liability include unearned income, prepaid revenue, deferred revenue and customers’ deposits.
• Unearned revenue is common in subscription-based businesses, software companies, airlines, and hospitality industries.

Let’s start by noting that under the accrual concept, income is recognized when earned regardless of when it is collected. 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. Smart Dashboards by Baremetrics make it easy to collect and visualize all of your sales data. Then, you’ll always know how much cash you have on hand, which clients have paid, and who you still owe services to.

Journal entry required to record liability at the time of sale of tickets:

It doesn’t matter that you have not earned the revenue, only that the cash has entered your company. However, in each accounting period, you will transfer part of the unearned revenue account into the revenue account as you fulfill that part of the contract. This journal entry reflects the fact that the business has an influx unearned revenue is recorded when of cash but that cash has been earned on credit. Unearned revenue is originally entered in the books as a debit to the cash account and a credit to the unearned revenue account. This is why unearned revenue is recorded as an equal decrease in unearned revenue (a liability account) and increase in revenue (an asset account). The business has not yet performed the service or sent the products paid for.

In this journal entry, the company recognizes the revenue during the period as well as eliminates the liability that it has recorded when it received the advance payment from the customers. Unearned revenue is a liability account which its normal balance is on the credit side. The amount of unearned revenue in this journal entry represents the obligation that the company has yet to perform. Proper management of unearned revenue ensures accurate financial statements, regulatory compliance, and tax efficiency.

Unearned revenue examples

It’s essential to consult with an accounting professional or refer to accounting guidelines specific to your jurisdiction to ensure proper recording of unearned revenue. Accounting practices vary based on industry, regulations, and local accounting standards. Over time, the revenue is recognized once the product/service is delivered (and the deferred revenue liability account declines as the revenue is recognized). Even if the company performs all its obligations and has earned the revenue per the accounting principle, it can’t record the income in the current period, resulting in unrecorded revenue.