What Is Unearned Revenue?
If your small business sells things like subscriptions, there's a chance you might have to deal with unearned revenue. Unearned revenue is exactly what it sounds like: revenue that you haven't earned yet.
You can think of unearned revenue as prepayment for something that you'll give to a customer in the future. Unlike earned revenue (which shows up as an asset), unearned income shows up as a liability on your balance sheet.
This article will go into more detail about what unearned revenue is, why it's important, and how to state it on a balance sheet. We'll also go over some examples of unearned revenue in a business setting.
If you're a small business owner or contractor, accounting is probably the last thing you want to do. Skynova has software that can make your accounting processes much more manageable.
Is Unearned Revenue an Income?
Unearned revenue is the money that a customer pays in advance for a service you'll provide them. In that sense, it's income that your company has collected but hasn't rendered services for. So, it's not included in an income statement.
Until your company provides the paid-for service, unearned income is recorded in a liability account on your balance sheet. As services are delivered, the money moves out of liabilities into assets. At that point, it becomes revenue and can be added to your income statement.
What Is the Difference Between Accrued Revenue and Unearned Revenue?
While unearned revenue consists of advance payments you haven't provided a service for yet, accrued revenue is money that a customer owes you for a service you've provided. Unlike unearned revenue, accrued revenue shows up on an income statement.
The Financial Accounting Standards Board (FASB) considers accrual accounting to fall under its revenue recognition principle. The revenue recognition principle is part of the generally accepted accounting principles (GAAP), which are rules for what should be reported on a financial statement and how it should be presented.
What Is the Difference Between Deferred Revenue and Unearned Revenue?
Deferred revenue is another term for unearned revenue. It can also be called deferred income. It's revenue your business receives before completing a job. The three terms are interchangeable, so it's up to you which term you prefer to use.
How Do You Record Unearned Revenue on a Balance Sheet?
While you don't have to record unearned revenue on your income statement, you'll need to record it on your balance sheet. Your balance sheet helps you understand your company's overall worth at a given accounting period.
Having an accurate balance sheet starts with having precise figures and accounting records. Over the next few sections, we'll go over how you can keep track of your unearned revenue and add it to your balance sheet.
Step 1: Determine Unearned Revenue
Before you can record your unearned revenue, you'll have to know how much unearned income your company has. When you're adding it up, be sure to take into account any money you receive for all jobs you haven't completed.
For example, if you charge a $100 monthly fee to use your online software tool, you might decide to offer a discount to clients who pay for the entire year upfront. A customer might pay $800 for the year, which is considered unearned revenue.
Some examples of things that generate unearned revenue include:
- Subscription services
- Rent payments
- Hotel bookings
- Down payments on things like construction
- Legal retainers
- Airline tickets or bus tickets
Step 2: Locate Unearned Revenue Under the Current Liabilities
Your balance sheet will have three main categories: assets, liabilities, and equity. Assets are everything of value that your company owns, like cash, investments, and inventory. Liabilities are everything of value that your company owes, like employee wages. Equity represents your shareholders' stake in your company. Equity is equal to your company's assets minus its liabilities.
Liabilities are split into long-term and current liabilities. Current liabilities are debts or services that need to be rendered within a year, such as wages or taxes. Long-term liabilities are debts or services that can be rendered over a longer period of time, like business loans.
Unearned income is usually a current liability, but there are situations where it can be a long-term liability. For example, if you own a construction business, you might have a contract to build a restaurant. The total project will take two years, but you require a 50% down payment from your customer. In this situation, the unearned income would be a long-term liability because it would take over a year for you to render services.
Step 3: Record Your Unearned Revenue
For your balance sheet to be accurate, you'll have to record your unearned revenue correctly in your accounting records. Remember that your total assets must equal your total liabilities and shareholder equity. That's why it's called a balance sheet. With that in mind, let's look at the process for recording unearned revenue.
You'll have to make two journal entries for unearned income: one when you receive the money and another after you perform the service. These entries will reflect the money's transition from unearned to earned revenue.
When you first receive the payment, enter it as a debit to your cash account and as a credit to your unearned revenue account. When you finish the job, enter the payment as a debit to your unearned revenue account and a credit to whichever revenue account it falls under.
We understand doing your own bookkeeping can be complicated. Thankfully, Skynova has software and templates that make accounting processes quick and simple.
What Is an Unearned Revenue Example?
Several types of businesses use unearned revenue to increase their cash flow. It can help a company pay for its operations without relying solely on capital. Below, we've provided a few real-world examples of how businesses can accept unearned income.
Unearned Revenue Example 1
A customer purchases a year's worth of guitar lessons in advance for $2,400. When the music teacher receives the money, a journal entry is made in the company's accounting records. The $2,400 is entered as a debit to cash and a credit to an unearned income account.
Lessons happen once a month, which means that each month, the guitar teacher earns $200 of the unearned revenue. An adjusting entry or accrual entry is made after each lesson, moving $200 in unearned revenue to revenue.
Each month, $200 is entered as a debit to unearned revenue and a credit to an account called "Lessons Revenue." At the end of the year, the entire $2,400 is transferred from unearned revenue to revenue.
Unearned Revenue Example 2
Newlyweds hire a construction contractor to build their dream home. The entire project will take a year and cost $800,000. For projects of this magnitude, the contractor requires a 25% down payment in advance of the work. The couple forks over $200,000 upfront.
The contractor enters $200,000 into their accounting software as a debit to cash and a credit to unearned revenue. At the end of the year, the job is completed and the income has now been earned. The contractor makes a journal entry adjusting the $200,000 down payment from unearned income to revenue.
The contractor enters $200,000 as a debit to unearned income and a credit to an account called "Homebuilding Revenue."
Let Skynova Help You Manage Your Small Business Cash Flow
If you have a startup, there's a number of reasons you might consider accepting unearned revenue. Getting paid in advance for your work ensures that you have the cash needed to run your business, and it eliminates the worry of whether you'll get paid fairly and on time.
However, remember that unearned revenue doesn't show up on an income statement. Money is only included on an income statement after it's earned. That's why it's so important to make accurate accounting records for your unearned income and keep track of when it becomes revenue.
Whatever your small business does, you want to spend your time doing more of it. Skynova can make that possible. Our software products and free templates can greatly limit the time you spend on accounting. Give us a try and see how easy handling your business finances can be.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional accountant for specific advice regarding your small business finances.