What Is Unearned Revenue? A Definition and Examples for Small Businesses

The customer gives the company $5,000 on December 28 and the company will begin work on the special order on January 3. On December 28 the company will debit Cash for $5,000 and will credit a liability account, such as Customer Deposits for $5,000. No revenue is reported in December for this special order since the company did not perform any work in December. When the special order begins and is completed in January, the company will debit https://www.bookstime.com/ the liability account for $5,000 and will credit a revenue account. However, since you have not yet earned the revenue, unearned revenue is shown as a liability to indicate that you still owe the client your services. Because there is a possibility that the services may not be performed they present a risk to the company. While it’s assumed that money will one day be recognized, it can’t be guaranteed until the work is performed.

James enjoys surprises, so he decides to order a six-month subscription service to a popular mystery box company from which he will receive a themed box each month full of surprise items. James pays Beeker’s Mystery Boxes $40 per box for a six-month subscription totalling $240. Because services have been delivered for January, you can recognize the amount of revenue that should be allocated to January, which is what is unearned revenue $1,000. The balance of the $12,000 payment remains in unearned revenue until goods and/or services have been delivered for February. As the business earns revenue, the unearned revenue balance is reduced with a debit, and the revenue account balance is increased with a credit. There’s always a risk that a client or customer could back out of a deal, or that your business won’t be able to fulfill the order.

Is unearned revenue debit or credit?

Recording unearned revenue is critical if you’re using the accrual accounting method and receiving a lot of advance payments. Then, in future periods, revenues and profits would be understated. It’s categorized as a current liability on a business’s balance sheet, a common financial statement in accounting. Unearned income or deferred income is a receipt of money before it has been earned. This is also referred to as deferred revenues or customer deposits.

• Unearned revenue is helpful to cash flow, according to Accounting Coach.
• As an example, we note that Salesforce.com reports unearned revenue as a liability .
• The customer can cancel their contract anytime before the meals are delivered, which makes unearned revenue or prepayments a liability to the company.
• No revenue is reported in December for this special order since the company did not perform any work in December.

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Every month the gym will make an entry to recognize the revenue from your membership. This will be a decrease in unearned revenue and increase in earned revenue . They will continue to recognize the $100 every month until you have “used up” your pre-paid membership.

It means you will recognize revenue on your revenue statement in the period you realize and earn it, not necessarily when you received it. Companies are turning to smarter, AI-oriented solutions for recognizing and reporting revenue, such as ProfitWell Recognized. Under the liability method, you initially enter unearned revenue in your books as a cash account debit and an unearned revenue account credit. 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 and deferred revenue are similar, referring to revenue that a business receives but has not yet earned. However, since the business is yet to provide actual goods or services, it considers unearned revenue as liabilities, as explained further below.

Recognition of Unearned Revenue

This entry recognizes $100 or 1/12 of the money in the current period. This adjusting entry would be done at the end of January when the books are closed. For deferred or unearned revenue, the customer pays in advance for goods or services that are provided later. FreshBooks has online accounting software for small businesses that makes it easy to generate balance sheets and view your unearned revenue.

• DebitCreditCash$10,000–Unearned Revenue–$10,000We see that the cash account increases, but the unearned revenue liability account also increases.
• Property management companies, or individuals who own real estate, may take advance rent payments.
• In two months, when the pallets are produced and delivered, an adjusting entry is made to move the money from unearned revenue to revenue for that fiscal period.
• There are a few additional factors to keep in mind for public companies.
• At the end of the month, the company has fulfilled 1/12 of its music-providing obligations; thus, the journal entry at the end of the month will show that 1/12 of the $100 has been earned.
• If the gym burned down in May and you could no longer go to the gym, the company would be “liable” to you for the remaining 7 months of membership dues that you paid for but did not get to use.

Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.

This could be any service that requires payment upfront for an ongoing product or service. Typically, the customer is billed at the beginning of the month.