At the end of every accounting period, businesses need to make adjusting entries in order to accurately prepare their financial statements.
One of these adjustments is for unearned revenue, or deferred revenue, that records the liabilities a business has to its clients who have paid for goods and services in advance.
So, since unearned revenue is considered a current responsibility, it falls under liabilities in the company’s balance sheet.
In this guide we will go through the details of what unearned revenue means in financial accounting and why it’s always a liability account.
Read on to learn:
- What Is Unearned Revenue?
- What Is a Liability?
- Is Unearned Revenue a Liability?
- Unearned Revenue FAQ
- Manage Your Liabilities with Accounting Software
What Is Unearned Revenue?
A lot of businesses provide subscription-based products or long-term memberships for their services.
And since clients usually pay in advance for these purchases, the revenue a business earns in this way is considered unearned revenue until the subscription or membership period has fully passed.
In short, unearned revenue is the payment a company has received for an uncompleted service. And since this good or service has yet to be earned, unearned revenue is recorded under liabilities in the balance sheet.
Now, you’re probably wondering: why can’t revenue be recorded immediately as an asset when the customer pays for it?
That’s because there are several accounting principles businesses are obliged to follow when creating their financial statements at the end of the year.
In the accrual basis of accounting (that’s the more popular of the two) revenue is recognized when it is earned, not when cash exchanges hands. The same rule applies to expenses: they are recorded when they occur, and not when money is paid.
To abide by these principles businesses make adjusting entries to the unearned revenue account to convert it into earned revenue over time.
If you want to learn more about these adjustments and how to record them in your accounting books, head over to our guide on adjusting entries.
What Is a Liability?
Liabilities (or payables) refer to the responsibilities a business has to its suppliers, employees, customers, and other third parties.
Liabilities can be either short or long-term.
Long-term liabilities are debts that will be settled within more than a year, such as a mortgage or a bank loan debt. Conversely, short-term liabilities refer to obligations that will be compensated within the year such as wages payable, accounts payable, taxes, unearned revenue, etc.
Is Unearned Revenue a Liability?
Yes, unearned revenue is a liability account.
As we previously mentioned, liabilities include any type of obligation a business has towards its creditors, employees, as well as clients.
And since unearned revenue records services yet to be provided to clients who have paid for them in advance, it counts as a current liability for the business.
At the same time, it can happen that the product or service doesn’t get delivered due to internal company issues, or that the client cancels their subscription/membership.
That’s why unearned revenue can’t be considered revenue and remains a liability until the owed good or service is fully delivered.
Unearned Revenue FAQ
#1. What’s the Difference Between Accrued and Unearned Revenue?
Accrued revenues represent goods and services that have been provided but not yet paid.
A common example of accrued revenue is selling to clients on credit. Accrued revenues are recorded under accounts receivable as assets the business owns.
In contrast to this, unearned revenue records the liabilities a business has towards its clients who’ve prepaid for goods or services.
#2. How Do You Adjust Unearned Revenue?
When an accounting period passes by, unearned revenue is adjusted into an asset by:
- Debiting the unearned revenue account
- Crediting the service revenue account
For more information on debit and credit entries check out our double-entry bookkeeping guide for small businesses.
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