What Is Unearned Revenue and How to Account for It

In other words, the payments collected from the customer would remain in deferred revenue until the customer has received what was due according to the contract. 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. 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.

How does deferred revenue work under cash and accrual accounting?

Using journal entries, accountants document the transactions involving unearned revenue in an organized manner. In other words, the payment received is for goods or services that will be delivered at some point in the future. As a result, the company owes the customer what was purchased, and funds can be reclaimed before delivery. Over time, when the product or service is delivered, the deferred revenue account is debited and the money is credited to revenue. In other words, the revenue or sale is finally recognized and the money earned is no longer a liability.

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. A similar term you might see under liabilities on a company’s balance sheet is accrued expenses. Unearned revenue, also known as unearned income, deferred revenue, or deferred income, represents proceeds already collected but not yet earned. Following the accrual concept of accounting, unearned revenues are considered as liabilities.

Financial Analysis and Transparency

First, since you have received cash from your clients, it appears as part of the cash and cash equivalents, which is an asset. This define costing can be anything from a 30-year mortgage on an office building to the bills you need to pay in the next 30 days. To determine when you should recognize revenue, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) presented and brought into force ASC 606.

Related AccountingTools Courses

1. However, even smaller companies can benefit from the added rules provided in the accrual system, so you may want to voluntarily work with accrual accounting from the start.
2. This method allows for a more accurate reflection of a company’s financial activities, providing a better understanding of the company’s overall financial health.
3. This is crucial in building trust among investors, shareholders, and other stakeholders.

In the entry above, we removed $6,000 from the $30,000 liability. Take note that the amount has not yet been earned, thus it is proper to record it as a liability. Now, what if at the end of the month, 20% of the unearned revenue has been rendered? However, since you have not yet earned the revenue, unearned revenue is shown as a liability to indicate that you still owe the client your services. Deferred revenue affects the income statement, balance sheet, and statement of cash flows differently. According to the accounting reporting principles, unearned revenue must be recorded as a liability.

While cash from deferred revenues might sit in your bank account just like cash from earned revenues, the two are not the same. If you don’t deliver the agreed-upon good or service, or your customer is unhappy with the end product, your deferred revenues could be at risk. Generally speaking, you should be more careful spending cash from deferred revenues than regular cash. Deferred revenue is classified as a liability, in part, to make sure your financial records don’t overstate the value of your business. A SaaS (software as a service) business that collects an annual subscription fee up front hasn’t done the hard work of retaining that business all year round. Classifying that upfront subscription revenue as “deferred” helps keep businesses honest about how much they’re really worth.

Unearned revenue, also known as deferred revenue or prepaid revenue, refers to the payments received by a company for goods or services that are yet to be delivered or provided. It is recorded as a liability on the company’s balance sheet because the company owes the delivery of the product or service to the customer. Examples of industries dealing with unearned revenue include Software as a Service (SaaS), subscription-based products, airline tickets, and advance payments for services. 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.

By understanding and accurately recording unearned revenue, businesses accounting for asset exchanges can better manage cash flow and service obligations to their customers. Deferred revenue is payment received from a customer before a product or service has been delivered. Deferred revenue, which is also referred to as unearned revenue, is listed as a liability on the balance sheet because, under accrual accounting, the revenue recognition process has not been completed. To stay compliant, entities must record unearned revenue as a liability on the balance sheet.

This changes if advance payments are made for services or goods due to be provided 12 months or more after the payment date. In such cases, the unearned revenue will appear as a long-term liability on the balance sheet. Unearned revenue and deferred revenue are interchangeable terms.

Whether you have earned revenue but not received the cash or have cash coming in that you have not yet earned, use Baremetrics to monitor your sales data. 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. Earned revenue means you have provided the goods or services and therefore have met your obligations in the purchase contract. Since the actual goods or services haven’t yet been provided, they are considered liabilities, according to Accountingverse. That means you would make the following journal entry on January 31st, to decrease the deferred revenue liability by $200 and increase membership revenue by $200. If your business uses the cash basis of accounting, you don’t have to worry about deferred revenue.

The credit and debit are the same amount, as is standard in double-entry bookkeeping. These rules can get complicated—and to top it off, the Financial Accounting Standards Board (FASB) recently overhauled them. For a detailed rundown of how to recognize revenue under the new GAAP rules, check out our guide to revenue recognition. Here, we’ll go over what exactly deferred revenue is, why it’s a liability, and how you can record it on your books. The statement of cash flows shows what money is flowing into or out of the company.

The best consultants, agencies, and specialized services to help you grow. With Stripe plus the Bench app, you can keep track of more than just payments. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.