This counts as a prepayment from the buyer’s perspective for goods and services that need to be supplied at a later date to them. ABC Co. receives a $10,000 advance through its bank account from a customer, XYZ Co., for future sales. Since ABC Co. has not transferred any goods or services in exchange, it must record the amount as a liability. Therefore, the accounting treatment for the transaction will be as follows. No, unearned revenue is not an asset but a liability, and you record it as such on a company’s balance sheet. Therefore, unrecorded income is also a form of earned revenue but due to some reason, the entity is yet to record it in the financial statements.

Once a company delivers its final product to the customer, only then does unearned revenue get reversed off the books and recognized as revenue on your profit and loss statement. An airline Industry usually receives the advance payment of tickets what is unearned revenue booked by customers. It is essential to understand that while analyzing a company, Unearned Sales Revenue should be taken into consideration as it is an indication of the growth visibility of the business. Higher Unearned income highlights the strong order inflow for the company and also results in good liquidity for the business as a whole.

Best Practices for Accounting for Unearned Revenue

Unearned revenue is great for a small business’s cash flow as the business now has the cash required to pay for any expenses related to the project in the future, according to Accounting Tools. According to the situation and the agreement between the parties, the unearned revenue entry might be different. Let us take different scenarios and discuss how to record them through the discussion below. Securities and Exchange Commission (SEC) that a public company must meet to recognize revenue. This will go against the matching principle because revenues have to be recognized in the period they were earned, along with expenses that related to that period. Some industries also have strict rules around what you’re able to do with deferred revenue.

When advance cash is received from customer:

As the business earns revenue, the unearned revenue balance is reduced with a debit, and the revenue account balance is increased with a credit. The initial entry for this liability is a debit to cash, and a credit to the unearned revenue account. Deferred revenue (aka unearned revenue) gets recorded on a company’s balance sheet as a liability. Unearned Sales results in cash exchange before revenue recognition for the business. Usually, this unearned revenue on the balance sheet is reported under current liabilities. However, if the unearned is not expected to be realized as actual sales, then it can be reported as a long-term liability.

On July 1, Magazine Inc received a $60 payment for a one-year subscription from a new customer. In effect, we are transferring $20,000, one-third of $60,000, from the Unearned Rent Income (a liability) to Rent Income (an income account) since that portion has already been earned. Let’s start by noting that under the accrual concept, income is recognized when earned regardless of when it is collected.

A variation on the revenue recognition approach noted in the preceding example is to recognize unearned revenue when there is evidence of actual usage. For example, Western Plowing might have instead elected to recognize the unearned revenue based on the assumption that it will plow for ABC 20 times over the course of the winter. Thus, if it plows five times during the first month of the winter, it could reasonably justify recognizing 25% of the unearned revenue (calculated as 5/20). This approach can be more precise than straight line recognition, but it relies upon the accuracy of the baseline number of units that are expected to be consumed (which may be incorrect).

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. You can only recognize unearned revenue in financial accounting after delivering a service or product and receiving payment. But since you accept payment in advance, you must defer its recognition until you meet the above criteria.

The revenue recognition concept states that the revenue should be recognized when the goods are delivered or services are rendered, and there is a certainty of payment realization. Therefore any unearned income should not be recognized as revenue and should be treated as a liability until the mentioned conditions are fulfilled. 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. First to recognize a liability on its balance sheet at the time of receiving advance payment.

• Once the invoice is issued in a later accounting period, the entry could be reversed by crediting the accounts receivable and debiting the accrued revenue account.
• Advance payments help companies and individuals with cash flow and other immediate payments which makes the production process faster.
• Only revenue that’s been earned or recognized shows up on the income statement.
• 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 great for a small business’s cash flow as the business now has the cash required to pay for any expenses related to the project in the future, according to Accounting Tools.

Unearned Revenue in the Books

If a business entered unearned revenue as an asset instead of a liability, then its total profit would be overstated in this accounting period. The accounting period were the revenue is actually earned will then be understated in terms of profit. Unearned revenue entry is a common feature in various industries. In fact, a lot of common items consumers purchase are based on this payment system such as subscription-based products, airplane tickets, prepaid insurance, retainers to attorneys, and so on. Unearned revenue is also referred to as deferred revenue and advance payments.

Financial stability is also gained by effectively managing unearned revenue. Its contribution is vital to the company’s overall success and sustainability. Whether unearned revenue should be categorized as a liability or not.

Suppose a SaaS company makes an advance collection of $30,000. The cash account will be debited while the unearned revenue account will be credited with this amount. Unearned revenue is defined as the payment the company receives for the product or service offered to the customer but accessible after a certain time. It is also known as prepaid revenue that companies gain before giving the service to the client.

Balance Sheet Presentation

For large projects, it may take weeks or months between when a customer prepays and when the final goods are delivered. So there needs to be a way to account for this money in the meantime. Hence, $ 1000 of unearned income will be recognized as service revenue.