In this article, I am going to go over the ins and outs of unearned revenue, when you should recognize revenue, and why it is a liability. Don’t worry if you don’t know much about accounting as I’ll illustrate everything with some examples. We are simply separating the earned part from the unearned portion. Unearned revenue is great for a small business’s cash flow as the business now has the cash required to pay for any expenses related to the project in the future, according to Accounting Tools. Since unearned revenue hasn’t actually been earned yet, it starts out as a liability on your books. It also goes by other names, like deferred income, unearned income, or deferred revenue.

Accurately recording your unearned revenue will help keep your books straight and provide valuable insights into the health of your business. Accrued revenue is the revenue you’ve already earned by providing goods and services to your customer, but have not yet received payment for. Companies can better plan their resources and allocate funds accordingly by receiving payments in advance. This can help with budgeting, forecasting, and managing cash flow more effectively, as there is greater visibility into future revenue streams.

HOW IS UNEARNED REVENUE CLASSIFIED IN FINANCIAL STATEMENTS?

This means that the revenues aren’t earned and thus cannot be reported as revenue until the service is carried out. If the service is eventually delivered to the customer, the revenue can now be recognized and the following journal where is unearned revenue recorded entries would be seen on the general ledger. From the date of initial payment, the payment is recorded as revenue on a monthly basis until the entirety of the promised benefits is confirmed to have been received by the customer.

This can be particularly beneficial for startups or businesses with limited working capital, as it allows them to cover operational expenses or invest in growth initiatives. Cash basis accounting is an accounting method whereby income and expenses are recognized only when cash is exchanged. Earned revenue means you have provided the goods or services and therefore have met your obligations in the purchase contract.

What Is Unearned Revenue and How to Account for It

When this happens, sometimes the transaction is recorded differently, resulting in the revenue being overstated and liabilities being understated. Sometimes the customer will pay half of the money before the service or good is provided and then pay the rest after the job is done. There is a difference in recording the revenue when it is earned and when the revenue is unearned. The main differences are the accounts they go to and how to report them in the general journal.

In wrapping up, understanding unearned revenue is indispensable for businesses aiming for accurate financial reporting. Unearned revenue reporting requirements are in place to ensure your financial statements always accurately reflect your actual financial position. Another unearned revenue example would be using a service, like web hosting services. If you pay for an annual subscription to a web-hosting plan, you’re only using the service a month at a time. Therefore, companies must record unearned income to align their income statement and balance sheet.

Unearned Revenue Under Cash Accounting

It doesn’t matter that you have not earned the revenue, only that the cash has entered your company. However, each accounting period, you will transfer part of the unearned revenue account into the revenue account as you fulfill that part of the contract. 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 owner enters $1200 as a debit to cash and $1200 as a credit to unearned revenue. At the end of the second quarter of 2020, Morningstar had $287 million in unearned revenue, up from $250 million from the prior-year end.

• Whether you have earned revenue but not received the cash or have cash coming in that you have not yet earned, use Baremetrics to monitor your sales data.
• The statement of cash flows shows what money is flowing into or out of the company.
• As the company performs the service or delivers the goods, it deducts the appropriate amount from the unearned revenue account.
• It also reduces the unearned revenue liability by the same amount, as the business no longer has an outstanding obligation related to this revenue.
• When they pay the rest and complete the transaction, they need to adjust the accounts.