What is unearned revenue?
Unearned revenue is prepaid revenue. In essence, the customer pays in advance for services that have not yet been performed by the recipient of the payment.
Is Unearned Revenue an Asset or a Liability?
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.
Accounting for Unearned Revenue
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). The unearned revenue account is usually classified as a current liability on the balance sheet.
If a company were not to deal with unearned revenue in this manner, and instead recognize it all at once, revenues and profits would
initially be overstated, and then understated for the additional periods during which the revenues and profits should have been recognized. This is also a violation of the matching principle. since revenues are being recognized at once, while related expenses are not being recognized until later periods.
Examples of Unearned Revenue
Examples of unearned revenue are:
- A rent payment made in advance
- A services contract paid in advance
- A legal retainer paid in advance
- Prepaid insurance
For example, ABC International hires Western Plowing to plow its parking lot, and pays $10,000 in advance, so that Western will give the company first plowing priority throughout the winter months. At the time of payment, Western has not yet earned the revenue, so it records all $10,000 in an Unearned Revenue account, using this unearned revenue journal entry: