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Unearned revenue, sometimes referred to as deferred revenue, is payment received by a company from a customer for products or services that will be delivered at some point in the future. The term is used in accrual accounting, in which revenue is recognized only when the payment has been received by a company AND the products or services have not yet been delivered to the customer. On 1st April, a customer paid $5,000 for installation services, which will render in the next five months.

• It is documented as a liability on the balance sheet as it represents a debt or outstanding balance that is owed to the customer.
• It’s a liability because it is a debt that’s still owed to the customer via the delivery of goods and services.
• In some industries, the unearned revenue comprises a large portion of total current liabilities of the entity.
• This balance will be zero at the end of September 2020 when the company completes the service it owes to the client.
• Until the company makes the sale, the amount paid by the customer is an obligation that will result in a future economic outflow.
• At the end of each reporting period, the revenue to be recognized for both methods is the same.
• High-growth SaaS companies like HubSpot and Atlassian routinely report deferred revenue and Remaining Performance Obligations (RPO) as proof of recurring demand.

Unearned revenue in cash accounting and accrual accounting

CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. Baremetrics integrates directly with your payment processor, so information about your customers is automatically piped into the Baremetrics dashboards. As a simple example, imagine you were contracted to paint the four walls of a building. Basically, ASC 606 stipulates that you recognize internally and for tax purposes revenue as you perform the obligations of your sales contract.

• Unearned revenue recognition will happen as soon as the service is provided.
• Unearned revenue entry is a common feature in various industries.
• While the cash is already in the bank, the revenue isn’t recognized on the income statement until the corresponding service is rendered.
• It also provides a leading indicator for sales momentum, customer trust, and long-term revenue visibility.
• Baremetrics provides an easy-to-read dashboard that gives you all the key metrics for your business, including MRR, ARR, LTV, total customers, and more.
• The unearned revenue account will be debited and the service revenues account will be credited the same amount, according to Accounting Coach.

Unearned revenue examples

Annual subscriptions are a form of unearned revenue for goods or services you deliver regularly over a year. Therefore, the revenue must initially be recognized as a liability. Note that when the delivery of goods or services is complete, the revenue recognized previously as a liability is recorded as revenue (i.e., the unearned revenue is then earned).

Deferred Revenue Explained: A Strategic Guide for Startup CFOs

Therefore, the journal entry to record this transaction is as follows. For help creating balance sheets that can track unearned revenue, consider using QuickBooks Online. QuickBooks offers a wide range of financial reporting capabilities, along with expense what is opening entry in accounting tracking and invoice features. Every month, once James receives his mystery boxes, Beeker’s will remove $40 from unearned revenue and convert it to revenue instead, as James is now in possession of the goods he purchased. Every business will have to deal with unearned revenue at some point or another. Small business owners must determine how best to manage and report unearned revenue within their accounting journals.

What are unearned revenues?

For example, a small business quotes a customer $500 to install a vanity. The customer chooses to pay the full amount before the work starts, so the income is recorded as a $500 debit in the cash account and a $500 credit in the ‘unearned revenue’ account. Two weeks later, when the project is finished, the business makes an adjusting entry, which debits $500 from the unearned revenue account and credits the revenue account $500. Other names used for this liability include unearned income, prepaid revenue, deferred revenue and customers’ deposits. The company can make the unearned revenue journal entry by debiting the cash account and crediting the unearned revenue account. Later on, when the business has actually provided the goods or services, an adjusting journal entry will be made.

What Is Unearned Revenue vs. Deferred Revenue?

It is a pre-payment on goods to be delivered or creating your time services provided. This is why unearned revenue is recorded as an equal decrease in unearned revenue (a liability account) and increase in revenue (an asset account). The business has not yet performed the service or sent the products paid for. Unearned revenue is reported on a business’s balance sheet, an important financial statement usually generated with accounting software. 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.

Under the accrual basis of accounting, revenues should be recognized in the period they are earned, regardless of when the payment is received. You will, therefore, need to make two double-entries in your business’s records when it comes to unearned revenue, once when it is received, and again when it is earned. Unearned revenue and deferred revenue are the same things, as are deferred income and unpaid income. These are are all various ways of referring to unearned revenue in accounting. In this guide, we look at examples of unearned revenue and explain how to record it in your financial statements.

Income Method

It is important to note that unearned revenue will have to remain a liability on the balance sheet until when the distribution or delivery of what the customer paid for has been done. It is when unearned revenue has been earned that it is converted from a current liability on the balance sheet to an actual revenue that is recorded on the income statement. Companies benefit greatly from customers paying in advance to receive their products or services.

However, in each accounting period, you will transfer part of the unearned revenue account into the revenue account as you fulfill that part of the contract. Conversely, if you have received revenue from a client but not yet earned it, then you record the unearned revenue in the deferred revenue journal, which is a liability. We are simply separating the earned part from the unearned portion. In the entry above, we removed $6,000 from the $30,000 liability. A similar situation occurs if cash is received from a customer in advance of the services being provided.

Depending on the agreement, your fee may be paid in advance, making it unearned revenue until you deliver your services for the period. 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? For example, suppose a business provides equipment maintenance services and invoices customers 6,000 annually in advance. When the invoice is issued, no maintenance cover has been provided and therefore the revenue of 6,000 is unearned and a journal entry is required. Let us understand how unearned revenue balance sheet documentation is carried out with the help of a few examples.

Accounting for unearned revenue on your financial statements is crucial, both as an accurate record of your financial position and to ensure you retain the right information for the ATO. Let’s assume, for example, Mexico Manufacturing Company receives $25,000 cash in advance from a buyer on December 1, 2021. The agreement pertaining to this transaction stats that the company must manufacture and provide goods to the buyer on reorder level of stock explanation formula example January 15, 2022 against the prepayment received from him on December 1, 2021. The amount of $25,000 will essentially appear as liability in the books of Mexico Company until it manufactures and actually delivers the goods to the buyer on January 15, 2022.

If you have noticed, what we are actually doing here is making sure that the earned part is included in income and the unearned part into liability. The adjusting entry will always depend upon the method used when the initial entry was made. Unearned revenue recognition will happen as soon as the service is provided. Another trend is pairing deferred revenue with metrics like Net Revenue Retention (NRR) and billings to get a complete view of sales momentum. Modern dashboards used by CFOs often show changes in deferred revenue alongside ARR growth.