Home » Bookkeeping articles » What Is The Difference Between Deferred Revenue And Unearned Revenue?

What Is The Difference Between Deferred Revenue And Unearned Revenue?

December 31, 2021
Bill Kimball

is unearned revenue a liability

Company XYZ sells $2,400 in gift cards to customers in February 2015. Your customer makes an advance payment for their first year upon subscription. This revenue is deferred until they have received a full year’s use of your service. So while the company has received cash in this period it will not record revenue.

How does revenue increase equity?

Why Revenues are Credited

Since the normal balance for owner’s equity is a credit balance, revenues must be recorded as a credit. At the end of the accounting year, the credit balances in the revenue accounts will be closed and transferred to the owner’s capital account, thereby increasing owner’s equity.

If neither state escheats gift cards, the state of sale may step in and exercise its right of escheat. It’s tempting to immediately update your income statement when deferred revenue comes in, but here are a few reasons that this approach can be troublesome for a subscription company. Take note that the amount has not yet been earned, thus it is proper to record it as a liability.

You collect it in advance, as prepayment before completing a project or delivering a service for a client. A company informs a new customer that a $5,000 deposit is required before it will begin work on the customer’s special order. The customer gives the company $5,000 on December 28 and the company will begin work on the special order on January 3.

More Accounting Topics

Accrued revenue—an asset on the balance sheet—is revenue that has been earned but for which no cash has been received. Unearned revenue can provide clues into future revenue, although investors should note the balance change could be due to a change in the business. Morningstar increased quarterly and monthly invoices but is less reliant on up-front payments from annual invoices, meaning the balance has been growing more slowly than in the past.

  • You’ve decided to begin a new revenue stream for your mid-sized employee engagement company.
  • This type of revenue is common among individual suppliers and companies dealing with subscription-based products or other services that require prepayments.
  • The liability arises from the fact that the company has collected money for the subscription but has not yet delivered the magazines.
  • DebitCreditRent Expense$250Prepaid Rent$250Under the cash basis of accounting, deferred revenue and expenses are not recorded because income and expenses are recorded as the cash comes in or goes out.
  • Another example of unearned revenue is rent that a landlord collects in advance.

All of the metrics you need to grow your subscription business, end-to-end. We’ve compiled a list of terms we think business owners should know.

Deferred Revenue: Unearned Income From Advance Prepayments

Using advance payments for services or goods can be a great way to bolster cash flow during periods of growth. In this article, we’ll show you what unearned revenue is, how it should be properly accounted for, and how it can help your business grow. No, unearned revenue is not an asset but a liability, and you record it as such on a company’s balance sheet. On a balance sheet, the “assets” side must always equal the “equity plus liabilities” side. Hence, you record prepaid revenue as an equal decrease in unearned revenue and increase in revenue .

To comply with GAAP procedures—especially as a publicly traded company—revenue is recorded when work is actually performed. Another way of stating this is that both the income from a project and the expenses for the project must be recorded in the same time period according to regulations by the Security and Exchange Commission . ProfitWell Recognized allows you to customize your financial reporting and statements.

Where Does Unearned Prepaid Revenue Go On A Balance Sheet?

Now, what if at the end of the month, 20% of the unearned revenue has been rendered? What is the difference between deferred revenue and unearned revenue? Well, the short answer is that both terms mean the same thing — that a business has been paid for goods or services it hasn’t provided yet. Here’s a more thorough description of deferred and unearned revenue, as well as a few examples to illustrate it. Every month the gym will make an entry to recognize the revenue from your membership.

is unearned revenue a liability

If that’s the case, unearned revenue is listed with long-term liabilities. Because the business has been paid but no product or service has been rendered, unearned revenue is considered a liability. The liability converts to an asset over time as the business delivers the product or service. Commonly referred to as unbilled receivables or progress payments to be billed.

Examples Of Unearned Income

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. 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. The company classifies the revenue as a short-term liability, meaning it expects the amount to be paid over one year for services to be provided over the same period.

Where once the $5,000 was a liability, it is now a cash asset on the income statement. You will only recognize unearned revenue once you deliver the product or service paid for in advance as per accrual accounting principles. It means you will recognize revenue on your revenue statement in the period you realize and earn it, not necessarily when you received it.

is unearned revenue a liability

For example, you can use it to set standard controls, rules, and methods to recognize revenue in a particular way. You can also use it to sort and analyze revenue received by criteria or automate amortization schedules. ProfitWell Recognized allows you to minimize and even eliminate human errors resulting from manual balance sheet entries.

Accrual Concept Of Accounting

Unearned revenue is helpful to cash flow, according to Accounting Coach. Deferred revenue is money received in advance for products or services that are going to be performed in the future.

On March 23, customer Jane Doe uses the card to purchase a $200 digital camera. The journal entries to record the sale and redemption of the gift card are shown in Exhibits 1 and 2. Revenue recognition standard offers advice on booking liabilities and breakage income for unredeemed gift cards. The initial accounting journal entry for a prepayment is a debit to the Cash in Bank asset account and a credit to the Deferred Unearned Revenue liability account.

Accrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. Contra accounts are used to record values that offset net revenue from actual revenue. If there is a sales revenue for $100 is unearned revenue a liability of a product sold and a $10 discount was applied to the product, a contra account for Sale Discounts would be used in the ledger to show the reason for the $10 difference in the net revenue of $90. When the cash is received, a liability account is created with corresponding equal entry in cash received.

Learn more about choosing the accrual vs. cash basis method for income and expenses. Unearned revenue is the amount that the company owes to the customer until an ordered product or service is delivered to him. The unearned revenue counts as a liability as the product remains refundable and cannot turn into income until the customer receives a product or a service in full. To account for this unearned rent, the landlord records a debit to the cash account and an offsetting credit to the unearned rent account . Under the cash basis of accounting, the landlord does not have any unearned rent. Instead, any rent payments received are recorded as income at once.

This liability represents an obligation of the company to render services or deliver goods in the future. It will be recognized as income only when the goods or services have been delivered or rendered. An excellent example of a business that deals with deferred revenue is one that sells subscriptions. Gradually, that revenue will shift from a liability to an asset as the company fulfills its obligations.

9In practice, the unearned revenue balance is commonly used to estimate a buyer’s future cost. Many companies will need to reclassify breakage income to be reported as part of sales revenue. Now consider a case in which the state with jurisdiction enforces escheatment laws for gift cards for 60% of unredeemed values.

When the service is delivered, it becomes reflected in the income statement. However, the company receives receipts, which leads to an increase in the cash flow that allows using the money. Therefore, unearned revenue increases cash flow and liability at the same time. According to accounting’s accrual concept, unearned revenues are considered liabilities. It is to be noted that under the accrual concept, income is recognized when earned, regardless of when collected.

What Is Prepaid

Deposits (whether refundable or non-refundable) and early or pre-payments should not be recognized as revenue until the revenue-producing event has occurred. In other words, deferred revenue requires some action on the part of the company before it can be considered an asset. If, for whatever reason, the company is unable to deliver the goods or services as promised, the deferred revenue must be refunded. Unearned revenue is income you have on your books that is waiting for the goods or services to go with it. For example, you sign a three-month, $1,000 per month deal with a customer in January, and the customer pays you $3,000.

Any business that takes upfront or prepayments before delivering products and services to customers has unearned revenue, which is often also called deferred revenue. Under the accrual basis of accounting, recording deferred revenues and expenses can help match income and expenses to when they are earned or incurred.

Any business that accrues unearned revenue should record it accordingly. First, it’s important to have resources planned for the future for product and service delivery. Without them, a business may be selling something they can’t support or deliver. The entity would allocate cash to the satisfied performance obligations while recording the remaining consideration due associated with the satisfied performance obligation as an unbilled receivable. Essentially not presenting a contract liability for maintenance paid for by the customer before performance. Deferred expenses, also called prepaid expenses or accrued expenses, refer to expenses that have been paid but not yet incurred by the business. Common prepaid expenses may include monthly rent or insurance payments that have been paid in advance.