What Is Unearned Revenue? A Definition And Examples For Small Businesses

April 1, 2025April 7, 2025

Many companies rely on automated accounting systems to handle entries efficiently, ensuring accuracy and maintaining a clear audit trail for internal reviews and external audits. Invest in accounting software total cost in economics to streamline tracking and reduce human error. Most unearned sources of revenue are not taxed on wages, and all sources of unearned revenue are not taxed on employment, such as Social security and Medicare. It is, therefore, essential that those producing unearned revenue understand where that revenue comes from and how each source is taxed. Additionally, as hybrid billing models gain traction (e.g., usage-based pricing), some companies split deferred revenue into fixed and variable components for clarity.

Therefore, at each balance sheet date, the utility must accrue for the revenues it earned but had not yet recorded. This is done through an accurual adjusting entry that debits a balance sheet receivable account and credits an income statement revenue account. Once goods or services have been rendered and a customer has received what they paid for, the business will need to revise the previous journal entry with another double-entry. This time, the company will debit its unearned revenue account while crediting its service revenues account for the appropriate amount. Unearned revenue should be entered into your journal as a credit to the unearned revenue account and as a debit to the cash account.

The earned revenue is recognized with an adjusting journal entry called an accrual. It’s categorized as a current liability on a business’s balance sheet, a common financial statement in accounting. Less common forms of unearned revenue include gifts, prizes, inheritances, and other unearned income. This is because the money was received without the participation of active work or business activity.

While the cash is already in the bank, the revenue isn’t recognized on the income statement until the corresponding service is rendered.
It is recognized as a liability account because the company still has to provide services or products to the company at a later date.
Create unlimited invoices with high accuracy and give new heights to the billing process.
You can also use it to sort and analyze revenue received by criteria or automate amortization schedules.
Most unearned sources of revenue are not taxed on wages, and all sources of unearned revenue are not taxed on employment, such as Social security and Medicare.
This time, the company will debit its unearned revenue account while crediting its service revenues account for the appropriate amount.

Why tracking revenue is important for your small business

Basically, ASC 606 stipulates that you recognize internally and for tax what does bopis stand for purposes revenue as you perform the obligations of your sales contract. Set aside time each month to review your revenue data, spot trends, and identify areas for improvement. You should recognize revenue according to the Generally Accepted Accounting Principles (GAAP) rules.

As the prepaid service or product is gradually delivered over time, it is recognized as revenue on the income statement. Unearned revenue is a liability to the business, so its initial entry would be a credit entry. This journal entry will show that the business has an influx of cash that has been earned on credit. Companies benefit greatly from customers paying in advance to receive their products or services. The cash flow from unearned revenue or deferred revenues can be invested right back into the business to purchase more inventory or pay off debts.

Similarly, some manufacturing or delivery orders require advance payments as a confirmation of the order. This deferring of revenue to the periods in which it is earned will often be recorded by using the liability account Deferred Revenues. The monthly entry for $2,000 is often described as a deferral adjusting entry. Services that will take over a year to deliver upon should be marked as a long-term liability on the balance sheet.

This means the business earns $10 per issue each month ($120 divided by 12 months).
The initial step in this process is the unearned revenue entry in the books as a cash account debit.
On January 1st, to recognize the increase in your cash position, you debit your cash account $300 while crediting your unearned revenue account to show that you owe your client the services.
Unearned revenue is usually disclosed as a current liability on a company’s balance sheet.
Until you “pay them back” in the form of the services owed, unearned revenue is listed as a liability to show that you have not yet provided the services.
In this situation, unearned means you have received money from a customer, but you still owe them your services.

Adjusting journal entries

Unearned revenue refers to income received from a customer for products or services that are yet to be delivered. Unearned revenue or deferred revenue is a form of advance payment received by a seller against a performance promise to the buyer. Like small businesses, larger companies can benefit from the cash flow of unearned revenue to pay for daily business operations.

What Is Unearned Revenue on a Balance Sheet?

If the contractor received full payment for the work ahead of the job getting started, they would then record the unearned revenue as $5,000 under the credit category on the balance sheet. The contractor would also record the $5,000 in cash under the debit category. At this point, you may be wondering how to calculate unearned revenue correctly. When a customer prepays for a service, your business will need to adjust its unearned revenue balance sheet and journal entries. Your business will need to credit one account and debit another account with the correct amounts using the double-entry accounting method. On January 1st, to recognize the increase in your cash position, you debit your cash account $300 while crediting your unearned revenue account to show that you owe your client the services.

This is against the IFRS 15 of international financial reporting standards. Unearned revenue is recorded as a current liability when the products or services are to be delivered in the next 12 months or lower than 12 months. Unearned revenue is not an uncommon liability; it can be seen on the balance sheet of many companies. Therefore, if a business records unearned revenue as a current liability in its balance sheet, it is in compliance with the GAAP rules and accrual accounting practices. In terms of accounting for unearned revenue, let’s say a contractor quotes a client $5,000 to remodel a bathroom.

Unearned revenue example in a balance sheet

A client purchases a package of 20 person training sessions for $2000, or $100 per session. The personal trainers enters $2000 as a debit to cash and $2000 as a credit to unearned revenue. At the end of the month, the owner debits unearned revenue $400 and credits revenue $400. He does so until the three months is up and he’s accounted for the entire $1200 in income both collected and earned out.

What is revenue? And what it means for your business

It is recognized as a liability account because the company still has to provide services or products to the company at a later date. Because of this prepayment, the seller has a liability equal to the unearned revenue or the cash received from the payer. Unearned revenues are useful for the seller for the cash flow performance because they have already received the cash while no service has been provided yet. In some industries, the unearned revenue comprises a large portion of total current liabilities of the entity. For example in air line industry, this liability arisen from tickets issued what is fica is it the same as social security for future flights consists of almost 50% of total current liabilities.

Therefore, it cannot be recorded as actual revenue or income for the seller. Retainer agreements, airline tickets, and subscription-based software are some of the businesses where this prepaid revenue occurs. The entity should carefully evaluate the circumstances and report the least possible and certain income. In practice, deferral refers to the delay in delivering the goods or services against which the entity has earned income. It means an entity cannot record the income as it has not yet fulfilled its trade contract with the counterparty. In some cases, a service or goods delivery contract may result in confirmed revenue for a company.

A publishing company may offer a yearly subscription of monthly issues for $120. This means the business earns $10 per issue each month ($120 divided by 12 months). Unearned revenue can only be recorded for entities using accrual accounting.

The application has introduced a new service that includes free shipping and gifts with a $50 subscription. The person will pay $50, but that will be unearned revenue for the company. The payment is received by the company but the customer availed of none of the services. This unearned revenue is later added to financial accounting when the company delivers the service or the product. However, this is only applicable when the business meets the below criteria as per the Securities and Exchange Commission (SEC). At the end of the six months, all unearned revenue has converted into revenue, since all money received accounts for the six mystery boxes that have been paid for.

This can also be done under a specific unearned revenue account type. The entire amount is documented as a liability on the balance sheet when the advance payment is received. As there is an obligation to the customer to deliver the goods, it is a major cause of existing liability. 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.

Most people are involved in some investment, be it debt or capital. If, for example, a person invests in a dividend-paying company such as Disney, they are likely to receive a dividend payout every quarter. Until 1984, in the UK, it was believed that it is an investment revenue because it is more permanent than earned revenue.