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. Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered. It can be thought of as a “prepayment” for goods or services that a person or company is expected to supply to the purchaser at a later date. As a result of this prepayment, the seller has a liability equal to the revenue earned until the good or service is delivered. This liability is noted under current liabilities, as it is expected to be settled within a year.
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. If a business entered unearned revenue as an asset instead of a liability, then its total profit would be overstated in this accounting period. The accounting period were the revenue is actually earned will then be understated in terms of profit. A variation on the revenue recognition approach noted in the preceding example is to recognize unearned revenue when there is evidence of actual usage.
Assets vs Liability: Why Is Unearned Revenue A Liability?
The payment is considered a liability because there is still the possibility that the good or service may not be delivered or the buyer might cancel the order. In either case, the company would repay the customer, unless other payment terms were explicitly stated in a signed contract. This reduces your deferred revenue by $549 from $6,688 to $6,139 in January’s book closing statement. This method will continue as you recognize $549 every month from your deferred revenue balance until it reaches 0.
Sierra and the league have worked out credit terms and a discount agreement. As such, the league can delay cash payment for ten days and receive a discount, or for thirty days with no discount assessed. Instead of cash increasing https://www.digitalconnectmag.com/a-deep-dive-into-law-firm-bookkeeping/ for Sierra, Accounts Receivable increases (debit) for the amount the football league owes. The important factor is that the company qualified for a 2% discount on inventory that had a retail price before discounts of $11,000.
Unearned revenue definition
Unearned revenue, also known as deferred revenue or customer deposits, refers to payments received by a company for products or services that have not yet been delivered or rendered. This unique financial concept holds a notable position on a company’s balance sheet, as it has implications for both revenue recognition and the company’s liabilities. When you receive unearned revenue, it means you have taken up front or pre-payments before the actual delivery of products or services, making it a liability.
For example, mortgage and rent payments are non-operating liabilities. Deferred revenue is revenue recorded for services or goods that are part of its operations; therefore, deferred revenue is an operating liability. A country club collects annual dues from its customers totaling $240, which is charged law firm bookkeeping immediately when a member signs up to join the club. Under the cash basis of accounting, deferred revenue and expenses are not recorded because income and expenses are recorded as the cash comes in or goes out. This makes the accounting easier, but isn’t so great for matching income and expenses.
Accounting for Unearned Revenue
In this case, the company has to hold onto the money until it can provide the product or service to the customer. A deferred revenue schedule is based on the contract between customer and provider. The contract will dictate when payments are due and when deliverables are to be met.
In your accounting, you will schedule unearned revenue adjusting entries to match these dates. Scheduling these entries will organize and automate deferred revenue recognition. The club would recognize $20 in revenue by debiting the deferred revenue account and crediting the sales account.
The debit and credit are of the same amount, the standard in double-entry bookkeeping. The first journal entry reflects that the business has received the cash it has earned on credit. Unearned revenue is a liability for the recipient of the payment, so the initial entry is a debit to the cash account and a credit to the unearned revenue account. As a company earns the revenue, it reduces the balance in the unearned revenue account (with a debit) and increases the balance in the revenue account (with a credit).