What Is Unearned Revenue?

Unearned revenue, also called delayed revenue, is a basic idea in accounting. It’s the money that a business gets ahead of time for things or services that it hasn’t yet delivered or performed. The company’s balance sheet shows that this advance payment is a debt, meaning it will have to pay money in the future.

Mostly, unearned income is paid before the goods or services are delivered or performed. One example is when a software company gets paid for a six-month license upfront. The money from this deal is not considered “earned” until the company has provided the software services for six months.

Synonyms

• Deferred revenue
• Prepaid revenue
• Customer deposits

Why it’s essential to keep track of unearned revenue

Unearned income must be tracked and accounted for in a business’s financial management. It is a big part of ensuring a company’s financial records are correct, which is essential for many reasons.

Making sure that financial statements are correct

A company is liable for unearned income because it represents a service or product that the company has to provide in the future. Ensuring that these amounts are correctly recorded as liabilities when the payment is received helps to ensure that the company’s financial statements accurately show its present financial situation. This level of accuracy is significant for making internal decisions like budgets and financial planning.

Making Sure of Transparency

Accurately recording irregular income also helps with openness. Business owners can give investors, creditors, and customers a clear picture of their financial responsibilities by clearly showing the amounts that have been received but for which the goods or services are still owed. This openness can help stakeholders trust and believe in the company more.

Compliance with Regulations

Not only is it good business to account for unearned income correctly, but it’s also required by some accounting standards, such as Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). According to these accrual accounting rules, future income must be recorded when made, not received. As a result, payments made for goods or services that will be given in the future must be recorded as unearned revenue, which is a liability, until the goods are delivered or the services are performed.

Dealing with Risk

Keeping accurate records of unexpected income can also help with managing risk. Businesses can better handle and plan for delivering goods or services linked to these liabilities if they know them and keep track of them. This can keep resources from being overcommitted and ensure the company is ready to meet its responsibilities.

Relations with Investors and Creditors

Investors and creditors often look closely at a business’s financial statements when making choices. A company can give a more accurate picture of its financial health and success if it keeps track of its unearned revenue. This could affect investment choices and the business’s ability to get loans or money.

In conclusion, properly recording unearned income is integral to a business’s financial management. It helps with accurate financial reporting, following the rules, managing risks well, and keeping good relationships with creditors and investors.

Unearned Income vs. Accrued Income

Accrued revenue is money that is owed but hasn’t been earned yet. Unearned revenue is paid for goods or services before they are delivered. It means you’ve earned money by selling goods or giving services, but the customer hasn’t yet paid you. This is called “accumulated revenue.” This can happen if a business gives a customer things or services on credit or has done work under a contract but hasn’t billed the customer yet.

In this case, the business has done what it needed to provide the goods or services and make money. But since it hasn’t gotten paid yet, it lists the amount on its balance sheet as an asset, specifically as accounts receivable. The company takes the money out of accounts receivable as soon as it gets paid.

The main difference between accrued and unearned revenue is when the deal happened and what the company owes. The company records unearned income as a liability because it is a future obligation. However, accrued revenue is a current asset for the business because it has already provided the goods or services and is just waiting to be paid.

Earned Revenue vs. Deferred Revenue

The ideas behind “deferred revenue” and “unearned revenue” differ but are the same in accounting. A company may use “deferred” or “unearned” depending on its taste or how people in its industry or area usually talk about it. It doesn’t matter what the company calls these deals; what matters is that it records them correctly so that its financial situation is clear and that it follows the revenue recognition principle.

Different Ways to Report Unearned Revenue

There are two main ways for a company to show unearned sales in its financial statements: the liability and income methods. Before and after each method, there are different rules about when and how to recognize unearned income.

Method of Liability

The most common way to report unearned income is the liability method also called the deferred method. When a business gets paid ahead of time for goods or services in this way, the whole amount is shown on the balance sheet as a liability. This debt is generally listed under “current liabilities” as “deferred revenue” or “unearned revenue.”

There is a responsibility because the business owes the customer money to deliver the goods or provide the services in the future. As the business meets this duty, it lowers its unearned revenue liability and counts the amount as revenue on its income statement.

For instance, if a business gets $12,000 for a one-year service contract in January, it would record the whole amount as “unearned revenue.” As it offers the service each month, it would take $1,000 off the unearned income and count that as revenue.

How to Earn Money

The income method is another way to report unearned income, though it is less usual. When this method is used, the unearned revenue is recorded as income when it is received instead of as a debt.

This method is usually used when the company is sure the goods or services will be provided without significant costs. It’s also used when the company doesn’t owe the customer anything else, and the cash received is non-refundable.

An example would be a company using the income method if it gets paid in full for a service it is likely to provide and won’t cost the company much.

The income method can make accounting more accessible. Still, it’s important to remember that it might not follow the revenue recognition principle in some accounting standards, like GAAP or IFRS, which says that revenue should be recognized when made. Because of this, businesses should carefully consider what they need to do to meet these standards when choosing how to report unearned income.

How to Keep Track of Unearned Income

For a business to stay financially honest, keeping accurate records of unearned income is important. Here is a more in-depth look at the steps that make up this process:

Putting unearned income into groups

To record unearned income, the first thing that needs to be done is correctly describing it. This grouping is based on the type of goods or services offered. If a business gets paid upfront for a yearly subscription service, that money is considered unearned revenue until the service is given to the customer.

Keeping track of cash and unearned income

The unearned income must be written down in the business’s financial records as soon as it is categorized. The money received is put in the asset account of the business as cash, and the same amount is put in the liability account as unearned income.

Estimating the Cost of a Service

Businesses should guess how much it costs to do specific service tasks so they can adequately record their income over time. This step is crucial for businesses that count revenue over time as the service is given.

Taking away from Unearned Revenue

The company takes the right amount of money from the unearned revenue account as it provides the service or sends the goods. This step lowers the company’s debt on the balance sheet and shows how far it has come in meeting its customer obligations.

Adding paid income to income

The amount taken from the account for unpaid revenue is then added to the account for earned revenue on the income statement. This process, called “revenue recognition,” ensures that the company’s income reports align with when the goods or services are delivered.

Following the steps for reporting

Companies must follow government and accounting standard reporting methods during this whole process. Following these rules helps the company stay aligned with financial rules and keep its reports accurate and honest. Companies need to know about any changes to these rules to continue to follow them.