Unearned RevenueDefined with Journal Entry Examples

Written By:
Adiste Mae

What is Unearned Revenue?

In the accrual basis of accounting, revenue is earned when goods are delivered or services are rendered even when it is not paid yet.

In the same way, when cash is already received and products or services are not yet fulfilled, it cannot yet be recorded as a revenue.

Instead, companies record the advance payment as Unearned Revenue.

Unearned Revenue is also known as Deferred Revenue or Advance Payments.

With the prepayment from a client or customer, it is expected that the goods or services will be fulfilled at a later date, typically within the year.

For this reason, Unearned Revenue is recorded under Current Liability in the Balance Sheet.

Understanding Unearned Revenue

Unearned Revenue is an account that is commonly used with companies who are selling subscription-based software, into real estate rentals, insurance, airline tickets, and other services or products that require advance payments.

From a cash flow perspective, advance payments can be advantageous to the company because of the benefits that the cash inflow can bring in the fulfillment of the company’s goals.

Recording Unearned Revenue

When a company receives advance payment, it is classified as Current Liability in the Balance Sheet.

The reason for this is that the money received in advance represents a liability that the company has to its customers to fulfill the service or goods purchased at a later date.

When the products are delivered and services are rendered, companies can then recognize the revenue.

Subscription-based contracts are perfect examples of unearned revenue recognition.

Suppose a design software costs $1,500 annually and is required to be paid upfront so that customers can begin using the product.

When the company receives the payment from the customer, Unearned Revenue or Deferred Revenue is created to represent the advance payment.

At the end of each month for the next 12 months, the company can recognize a revenue of $125 monthly.

For each month that revenue increases by $125, the unearned revenue account decreases by the same amount.

Because most advance payments from clients or customers are annual (can be recognized within 12 months), Unearned Revenue is considered as a Current Liability.

However, if the prepayment is more than 12 months, that portion will be reclassified as a Long Term Liability on the Balance Sheet.

Unearned Revenue Reporting Requirements

Under the Securities and Exchange Commission, there are five criteria that must be met in order for companies to recognize revenue:

• Collection of the amount for the sale is probable.
• Delivery is completed.
• The ownership has passed on to the buyer.
• There is evidence of the arrangement.
• Price of the product or service is determinable.

If all of the above criteria is not satisfied, a company cannot yet recognize revenue and if payment has already been received, the amount received should be recorded as Unearned Revenue.

Example of Unearned Revenue

ABC Real Estate rents out office spaces for several businesses.

For the year 2021, they received a total of $425,000 of 12 months advance payments from their customers.

Not meeting the criteria set before recording revenue, the cash receipt will not be recorded as revenue but instead, it shall be recorded as a liability.

The accountant of ABC Real Estate will record the receipt of advance rental payments as:

Debit Cash $425,000

    Credit Deferred Revenue $425,000

For each month, at the end of the period, ABC Real Estate can recognize revenue from their rental properties and record it with a journal entry to increase revenue and decrease the liability of $35,416.67 ($425,000 / 12 months).

Debit Deferred Revenue $35,416.67 

    Credit Rental Revenue $35,416.67

At the end of the 12-month period, revenue is fully recognized and unearned revenue is reduced to zero.