Recording and accounting for unearned revenue can be slightly more complicated than other types of transactions. This form of revenue is accounted for twice – when it's paid, and when the service or product is delivered.
In this guide, we look at examples of unearned revenue and explain how to record it in your financial statements.
What is unearned revenue?
Unearned revenue, also called deferred revenue or advanced payment, is money that has been paid to your business for goods or services that you have not yet delivered. Essentially, it's a cash prepayment in exchange for the promise of goods or services.
While unearned revenue appears as cash in your account, in accounting terms, it's considered a liability until your business delivers the goods or services as agreed. For this reason, it's recorded as a current liability on your balance sheet and credited to your unearned revenue account, not your cash account.
Examples of unearned revenue
Unearned revenue is any payment made in advance, for example, retainers for ongoing services, annual subscriptions, vouchers, gift cards or prepaid rent.
Service retainers paid in advance
A service retainer is paid as part of a service agreement, in which your business agrees to provide a specific level of service at a negotiated rate. Depending on the agreement, your fee may be paid in advance, making it unearned revenue until you deliver your services for the period.
Annual subscriptions
Annual subscriptions are a form of unearned revenue for goods or services you deliver regularly over a year. For example, a customer could pay for a full 12-month software subscription at the beginning of the year in exchange for 12 months of service, or pay a yearly magazine subscription and receive a magazine each month.
Prepaid rent
Prepaid rent is another common form of unearned revenue. Rent is often paid a month ahead, which means that each payment is considered unearned revenue until the following month.
How to record unearned revenue
To record unearned revenue, you generally need to enter the amount in two places – as a credit to your unearned revenue account and a debit to your cash account. This shows that you've received cash but still owe the customer goods or services in return.
Unearned revenue journal entry
An unearned revenue journal entry involves recording a double entry in your accounts records when you receive payment, then another double entry when you supply the service or product to your client.
Essentially, when the money comes in, you record it as a credit in the ‘unearned revenue’ column and a debit in your cash account. When the service is delivered and you have earned the revenue, you record another double entry with credit and debit reversed.
Here’s an example:
Entry when payment is made:
Cash: Debit $465
Unearned revenue: Credit $465
Entry when goods or services are delivered:
Unearned revenue: Debit $465
Revenue: Credit $465
How to account for unearned revenue on financial statements
Accounting for unearned revenue on your financial statements is crucial, both as an accurate record of your financial position and to ensure you retain the right information for the ATO.
Under the principles of accrual accounting, revenue is recognised as income when it's earned, not when cash enters your account (cash accounting). This means unearned revenue is listed as a liability on your balance sheet until your business delivers the promised services or goods. Then, the amount can be listed on your income statement.
Balance sheet
On your balance sheet, unearned revenue should be listed under current liabilities and added to your total liability amount.
Income statement
Your income statement should not record unearned revenue until it becomes ‘earned’ revenue when the service or product is delivered.
Cash flow statement
Your cash flow statement records cash coming into your business, whether earned or unearned. Unearned revenue should be listed as a credit in the operating activities section of your cash flow statement.
Unearned revenue FAQs
Is unearned revenue a current liability?
Yes, unearned revenue is usually listed as a current liability on your balance sheet. This reflects the fact that this form of revenue functions as a debt to a client or customer until you deliver the product or service they have paid for. It's a liability because it is a debt that's still owed to the customer via the delivery of goods and services.
How do you adjust unearned revenue?
You need to adjust unearned revenue once it's been earned; that is when your business has supplied the promised goods or services. Adjust the entry in your financial records by moving the revenue from unearned revenue on the balance sheet to earned revenue on the profit and loss statement.
For example, a small business quotes a customer $500 to install a vanity. The customer chooses to pay the full amount before the work starts, so the income is recorded as a $500 debit in the cash account and a $500 credit in the 'unearned revenue' account. Two weeks later, when the project is finished, the business makes an adjusting entry, which debits $500 from the unearned revenue account and credits the revenue account $500.
What is the difference between unearned revenue and accounts receivable?
Accounts receivable represents money that you're owed for work that has already been completed and has been invoiced and awaiting payment by your customer. Unearned revenue is money that you've been paid for work that has yet to be done. For that reason, they appear in different places on your balance sheet — accounts receivable is listed as an asset, while unearned revenue is listed as a current liability.
Get an in-house accounting expert
If numbers and accounts aren't your forte, dealing with accounting concepts like unearned revenue can be challenging. It's hard to know exactly where and how to list income on your financial statements, how to record revenue and when to make adjustments. Always consult your bookkeeper or accountant for advice on these types of transactions.
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