September 09, 2019

What is Unearned Revenue in Accounting?


What is Unearned Revenue in Accounting?

Revenue is an increase in the economic benefits of an enterprise during the reporting period in the form of a receipt or growth in the utility of assets, or a decrease in its liabilities, resulting in an increase in equity, with the exception of an increase related to the contributions of participants.
Revenues can be the result of the supply or production of goods, the provision of services, and other activities of an enterprise. The definition of revenue includes income from ordinary activities and profits from other operations, such as an increase in the value of stocks, bonds, investments, foreign exchange gains, etc. Revenues from ordinary activities are incomes that arise in the course of regular activities of a business entity and are denoted by different names, namely: revenue, fees, interest, dividends and royalties.

What is Unearned Revenue and When Does it Occur?

Unearned revenue is funds that a company received for goods or services that it has yet to provide. Thus, unearned revenue is the amount of money that buyers paid but will receive goods or services they paid for only in the future. For example, this can be rent paid in advance or other advance payments received from customers. Other examples include:

  • Subscription payments
  • Airline, sports and concert tickets
  • Prepaid insurance
  • Service contracts, etc.

Cash flow coming in and out of the company have to be recorded in some way. The unearned revenue in the company’s balance sheet is usually treated as a current liability and is expected to be moved to earned revenues during the relevant reporting period. Only when the company fulfills its obligations, and unearned revenues move to revenues, they can be included in the income statement. Otherwise, unearned revenues cannot be included under revenues in the income statement.
Companies prefer unearned revenues in the form of cash because this way, they can be sure that the buyer is committed to purchasing goods or services from them. Thus, when unearned revenues are recorded the cash account under the assets is debited, and the unearned revenues account under liabilities is also increased.
However, there might be cases when the company is unable to perform the necessary actions to deliver the goods or services to its customers. In this case, customers are refunded their money, and the unearned revenue account decreases.
In most cases, the company can use the money that customers paid in advance to cover any expenses associated with fulfillment of obligations on their part, making it much easier for businesses to ensure that their customers are satisfied and get what they paid for. It should be noted that unearned revenue can include only a partial payment for the services or goods that the company will provide to secure the agreement with at least some of the money paid upfront.

Unearned Revenue Benefits

Real estate and insurance companies have the most unearned revenue because these companies require their client to pay in advance and only after making the payment, the clients can get access to the rented property or get the insurance to cover the incident. The benefit of receiving unearned revenue for the companies is a significant cash income that they can use to provide those services and goods. This means that they do not need to have considerable capital before being able to sell something to the buyers.
Companies who have unearned revenue accounts can also show potential investors how much revenue they expect to earn in the upcoming period. This, in turn, makes it easier to make predictions of future profits and evaluate the advantages and disadvantages of investing in a particular company. Substantial unearned revenues demonstrate that customers trust the company, which further increases the value of any enterprise.
Another advantage of the unearned revenue is an ability to use this accounting concept to accurately record all the transactions and operations that happen in the business. It helps to evaluate the company’s financial state better and plan for the future.

Difference Between Deferred Revenue and Unearned Revenue

You just got an answer to the question “What is unearned revenue?” and now might be confused by another accounting term deferred revenue. The good news is that both the deferred revenue and unearned revenue mean precisely the same thing. In other words, both partial and unearned revenue refers to the money that the company received from its customers but still needs to perform services for them or deliver goods.
Deferred revenue, just like the unearned revenue, is considered a company’s liability because they have not yet earned these funds. Only once the goods have been delivered, or the services have been provided, the company can transfer all or part of the unearned revenue to the assets side of the business equation and count it as revenue.

What Types of Companies Have Unearned Revenue?

 What Types of Companies Have Unearned Revenue?

Companies that accept or require payments in advance have the most unearned revenues. Such companies will have an obligation to provide the services or goods according to the agreement, and if they fail to do so, they will have to make a refund. Although any company can come across a situation where it would have to be aware how to keep a record of unearned revenues, there are companies for which unearned revenue makes up a large part of their transaction records.
Subscription-Based Companies
Magazine and newspaper publishing companies are a great example of an industry that has a relatively large amount of cash flow in the unearned revenues account. The subscription-based sector is not limited to publishers. It also includes companies that provide software on a subscription as well as fitness centers that take membership fees a month or even a year in advance.
Ticket Sellers
Tickets are another excellent example of goods that are paid for before they are used. You might think of sports and concert tickets that are usually bought well in advance of the actual event. Companies who sell these tickets record the payments as unearned revenue, and only after the event is over, they transfer these funds into the revenues account. Airlines also belong to this category as they also sell their tickets a month or more before the actual flight. Prepaid services
You might be familiar with prepaid services from personal experience. Maintenance services, lawn care, and household cleaning are the most popular. Money can be paid in advance with a product purchase, such as electronics, or an individual or business can sign a contract for service provision for a certain period and pay for these services in one lump sum at the time of contract conclusion. The company that will provide these services will record the cash flow from the payment as unearned revenue.
Goods Sellers
Online sellers of goods such as Amazon take payments for their products before the customer receives the goods. They will not even ship the goods until they receive the payment. This allows them to secure the payment and be sure that they would not have to track the buyers to receive a payment for the goods they sold. Sellers that fulfill special/custom orders are more likely to require a down payment, especially if the materials are expensive, and will acquire unearned revenues.

Unearned Revenue Examples

Just like expenses that can be paid before the goods or services are used, income can be received even before it is earned. If revenues are received in advance, the company undertakes to deliver goods or provide services in the future. Therefore, unearned (deferred) income is attributed to the liability accounts.For example, publishers usually receive a payment for a subscription to magazines in advance. Received payments are recorded on the liabilities account. If the publisher does not deliver the paid issues of magazines, then readers are supposed to get their money back. As each issue of the magazine is delivered, the publisher earns a portion of the funds received in advance. This earned part must be transferred from the “Unearned Subscription” account to the “Subscription Revenue” account. In other words, the amounts are transferred from liabilities to assets side of the balance sheet. Let’s review another example of unearned revenue and see how it is recorded. For instance, on February 1, a company received a $13,500 payment from a customer for maintenance services to be provided over the next two months. The entry to record the receipt of cash would be:

 What Types of Companies Have Unearned Revenue?

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