Services that will take over a year to deliver upon should be marked as a long-term liability on the balance sheet. In the income method, when a payment is received, it is noted as credit in the balance sheet. But, as the product or service is delivered, and as payments are earned the credit is step by step converted into debit payments. Look below to see an example of the two journal entries your business will need to create when recording unearned revenue. Taking the previous example from above, Beeker’s Mystery Boxes will record the transactions with James in their accounting journals.
After a month, it has constructed a mile-long road, it gets paid one hundred thousand dollars, and the company debits this amount from the five hundred thousand dollars. In effect, we are transferring $20,000, one-third of $60,000, from the Unearned Rent Income (a liability) to Rent Income (an income account) since that portion has already been earned. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. This is done because, in many subscription contracts, a clause allows the customer to cancel the software subscription.
Accounting for Unearned Revenue
It is treated as a liability because the revenue has still not been earned and represents products or services owed to a customer. As the prepaid service or product is gradually delivered over time, it is recognized as revenue on the income statement. Unearned revenue, also known as deferred revenue, is a crucial element in a company’s financial statements. It represents the money received by a company for goods or services that have not yet been delivered.
Therefore, companies should carefully consider their obligations under these standards when choosing their method for reporting unearned income. The liability exists because the company has an obligation to the customer to deliver the goods or perform the services in the future. As the company fulfills this obligation, it gradually reduces the unearned revenue liability and recognizes the amount as revenue on its income statement.
How to Present an Increase in Intangibles in Cash Flow Statement
Clear disclosure helps ensure transparency and accurate financial reporting for investors and other stakeholders. Once goods or services have been rendered and a customer has received what they paid for, the business will need to revise the previous journal entry with another double-entry. This time, the company will debit its unearned revenue unearned revenue is classified as account while crediting its service revenues account for the appropriate amount. Some examples of unearned revenue include advance rent payments, annual subscriptions for a software license, and prepaid insurance. The recognition of deferred revenue is quite common for insurance companies and software as a service (SaaS) companies.