Unearned Revenue

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Unearned Revenue

Unearned revenue (also called deferred revenue) is cash a company receives before delivering goods or performing services. Because the company still owes the customer product or service, the payment is recorded as a liability until the obligation is fulfilled and revenue can be recognized.

Why it matters

  • Improves near‑term cash flow by providing funds in advance of delivery.
  • Signals future revenue to investors but can also reflect changes in billing practices (e.g., more monthly invoicing vs. annual prepayments).
  • Affects balance sheet composition and timing of reported earnings.

Common examples

  • Subscription services (streaming, software-as-a-service)
  • Magazine and newspaper subscriptions
  • Prepaid rent or insurance
  • Airline tickets and event advance sales
  • Legal retainers

How unearned revenue is recorded

  1. Initial receipt (liability created)
  2. Debit Cash

  3. Credit Unearned Revenue (liability)

  4. As goods/services are delivered (revenue recognized)

  5. Debit Unearned Revenue
  6. Credit Revenue (income statement)

Example: A publisher takes $1,200 for a one‑year monthly subscription. At sale:
– Debit Cash $1,200; Credit Unearned Revenue $1,200.
Each month, when an issue is delivered:
– Debit Unearned Revenue $100; Credit Subscription Revenue $100.

Classification: Unearned revenue is generally a current liability when the related goods/services will be provided within 12 months. If delivery is expected after 12 months, it is classified as a long‑term liability.

Reporting and recognition requirements

Public companies must meet revenue recognition criteria before recording revenue. Key conditions commonly required include:
– Persuasive evidence of an arrangement with the customer.
– Delivery is complete or ownership/benefit has transferred to the buyer.
– The price is fixed or determinable.
– Collectibility of the payment is probable (reasonable estimate for allowance for doubtful accounts).

If these criteria are not met, recognition is deferred and the amount remains a liability.

Example in practice

A financial‑services firm selling subscription products may collect annual fees in advance. Those upfront payments are recorded as deferred (unearned) revenue and recognized over the subscription period. Changes in invoicing frequency (more monthly vs. annual billing) can slow growth in deferred revenue even if underlying sales grow.

Key takeaways

  • Unearned revenue is advance payment for goods or services not yet delivered and is recorded as a liability.
  • Revenue is recognized on the income statement gradually as the seller fulfills its obligations.
  • Proper classification (current vs. long‑term) depends on the expected timing of delivery.
  • Public companies must meet recognition criteria before converting unearned revenue to earned revenue.