Unearned Revenue: What It Is, How It Is Recorded and Reported

While unearned revenue is disclosed as a current liability on a balance sheet, this changes if advance payments are made for 12 months or more. In such cases, unearned revenue is recorded as a long-term liability. Receiving unearned revenue means that you have received payments for products or services before they have been delivered. This creates a liability, as the customer has paid for something that has not yet been provided. Over time, however, this liability becomes an asset, as you deliver the product or service.

• This is referred to as an onerous contract, a concept that will be discussed later in the chapter.
• For example, many grocery and other retail stores allow customers to collect points that can be applied against future purchases.
• You record prepaid revenue as soon as you receive it in your company’s balance sheet but as a liability.
• This method was more commonly used prior to the ability to do the calculations using calculators or computers, because the calculation was easier to perform.
• In some cases, the value of the warranty may be explicitly stated, as is the case with extended warranties that require separate payment from the product itself, such as those sold by automobile retailers.

Therefore, you cannot report these revenues on the income statement. Instead, you will report them on your balance sheet as a liability. Deferred revenue refers to money you receive in advance for products you will supply or services you will perform in the future.

Why Is Deferred Revenue Treated As a Liability?

The burn rate is the metric defining the monthly and annual cash needs of a company. It is used to help calculate how long the company can maintain operations before becoming insolvent. The proper classification of liabilities as current assists decision-makers in determining the short-term and long-term cash needs of a company. The initial entry for this liability is a debit to cash, and a credit to the unearned revenue account. Deferred revenue (aka unearned revenue) gets recorded on a company’s balance sheet as a liability.

As you learned when studying the accounting cycle, we are applying the principles of accrual accounting when revenues and expenses are recognized in different months or years. You record prepaid revenue as soon as you receive it in your company’s balance sheet but as a liability. Therefore, you will debit the cash entry and credit unearned revenue under current liabilities. After you provide the products or services, you will adjust the journal entry once you recognize the money.

Unearned revenue and the conservatism principle

Income taxes are required to be withheld from an employee’s salary for payment to a federal, state, or local authority (hence they are known as withholding taxes). The $3,500 is recognized in Interest Payable (a credit) and Interest Expense (a debit). https://investrecords.com/the-importance-of-accurate-bookkeeping-for-law-firms-a-comprehensive-guide/ For items like these, a customer pays outright before the revenue-producing event occurs. Learn what financial reporting is and how to use a financial report for analysis. See a financial report example containing the three core financial statements.

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. Therefore, the revenue must initially be recognized as a liability.

Deferred Revenue Recognition Compliance

In some cases, the value of the warranty may be explicitly stated, as is the case with extended warranties that require separate payment from the product itself, such as those sold by automobile retailers. In other cases, however, the price of the warranty may be implicitly included with the total sale price of the product. This is essentially a bundled sale, which was discussed previously in the revenue chapter. Unearned revenue is a type of liability account in financial reporting because it is an amount a business owes buyers or customers.

The first is as a debit to the cash account to represent that work has yet to be performed by the company to “earn” the advance payment. The second entry is as a credit to unearned revenue; the value of which is available funds The Importance of Accurate Bookkeeping for Law Firms: A Comprehensive Guide for the work to be performed. Taxes payable refers to a liability created when a company collects taxes on behalf of employees and customers or for tax obligations owed by the company, such as sales taxes or income taxes.