What Is Unearned Revenue?

For example, the publisher needs the cash flow to produce content through its various teams, market the content compelling to reach its audience, and print and distribute issues upon publication. Each activity in a publisher’s business strategy can benefit from the resulting cash flow of unearned revenue. 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.

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. Positive cash flow can keep a small business’s operations thriving. However, a business owner must ensure the timely delivery of products to its consumers to keep transactions steady and drive customer retention. This is why it is crucial to recognize unearned revenue as a liability, not as revenue. Generally, unearned revenues are classified as short-term liabilities because the obligation is typically fulfilled within a period of less than a year. 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.

Unearned Revenue

Think of it as a customer paying for monthly service, but you already have the money. This decreases your unearned revenue liability because you performed the service. Unearned revenue is the money received by a business from a customer in advance of a good or service being delivered. It is the prepayment a business accrues and is recorded as a liability on the balance sheet until the customer is provided a service or receives a product. The rationale behind this is that despite the company receiving payment from a customer, it still owes the delivery of a product or service. If the company fails to deliver the promised product or service or a customer cancels the order, the company will owe the money paid by the customer.

Unearned revenue is also known as deferred revenue or deferred income. It is a prepayment received by an individual supplier or a company from a customer who ordered the delivery of goods or services at a later date. Any company or individual supplier who has received an unearned revenue has a liability equal to that “prepayment” until the goods or services are delivered. Since it is not yet earned, this revenue is like a debt owed to customers. Companies or individual suppliers with unearned revenue usually record it in their balance sheets as a liability.

unearned revenue(s) definition

Therefore, the revenue must initially be recognized as a liability. Note that when the delivery of goods or services is complete, the revenue recognized previously as a liability https://accounting-services.net/what-is-a-note-payable/ is recorded as revenue (i.e., the unearned revenue is then earned). Revenue is earned when a company delivers the goods or services for which it has received payment.

According to the accounting reporting principles, unearned revenue must be recorded as a liability. If the value was entered as an asset rather than a liability, the business’s profit would be overstated for that accounting period. According to the accounting equation, assets should equal the sum of equity plus liabilities. In the case of subscription services, revenue installments are made at different times during the contract. For annual contracts, a prepayment is made at the beginning of the period. A business then would perform the service monthly and recognize a certain amount of revenue each month.

Collection of Unearned Revenue

If you have booked revenue too early you will need to start from scratch and recalculate your earnings for all accounts. Improper revenue recognition will result in an overstated revenue What Is Unearned Revenue? account balance, and understated deferred income account balance. In accrual accounting, it is important to organize income properly, especially when it comes to prepaid services.