Whether you're running a small startup or an established company, understanding unearned revenue can help you manage your cash flow and stay on top of your accounting game.
In this guide, we’ll unpack what unearned revenue means and explain why it matters for your business's financial health. We’ll also provide tips on how to track it.
Unearned revenue refers to the money that businesses collect from customers for their products or services that have not yet been provided.
Think of it as a financial promise – money you've received for goods or services you'll deliver in the future. It's like being paid in advance for a job you're about to start, or collecting subscription fees before sending out the first monthly packages.
In your books, unearned revenue sits on your balance sheet as a "current liability" – basically, it's a reminder that you owe your customer something. Once you deliver what you promised, you can change the unearned revenue accounting entry and call it "revenue".
Australian businesses have a smart framework for handling unearned revenue through AASB 15 (Australian Accounting Standards Board). This standard helps you track your financial obligations accurately, ensuring you're reporting exactly what you've earned.
AASB 15 sets out when and how revenue should be recognised. Under this standard, unearned revenue must remain on the books as a liability until the obligation to the customer is fulfilled.
Following these rules isn't just about staying on the right side of the taxation office – it also helps give an accurate picture of how your business is really doing.
Every journal entry of unearned revenue must also account for GST implications. When you receive a prepayment, you might need to pay GST right away – even before you've actually delivered the goods or services. The golden rule? Keep good records and don't be afraid to chat with a tax professional who can help you navigate the specifics.
According to the Australian Taxation Office (ATO):
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Unearned revenue and deferred revenue are the same thing. As well as deferred income and unpaid income, they are all various ways of saying “unearned revenue” in accounting.
However, unearned revenue differs from “accrued revenue”. Accrued revenue occurs when a business provides a service but has not yet received payment, whereas unearned revenue is when a business receives payment before delivering the service.
So, what is unearned revenue in practice?
Let’s take a look at different examples of Australian businesses that would collect unearned revenue:
For an unearned revenue example, let's take a look at James. James enjoys surprises, so he decides to order a six-month subscription service to a popular mystery box company where he will receive a themed box each month full of surprise items. James pays Beeker's Mystery Boxes $40 per box for a six-month subscription totalling $240.
After James pays the store this amount, he has not yet received his monthly boxes. Therefore, Beeker's Mystery Boxes would record $240 as unearned revenue in their records.
Every month, once James receives his mystery boxes, Beeker's will remove $40 from unearned revenue and convert it to revenue instead, as James is now in possession of the goods he purchased. At the end of the six months, all unearned revenue has converted into revenue, as James has received all six mystery boxes he first paid for.
To demonstrate unearned revenue accounting entry methods, here is an example of Beeker’s Mystery Box and what their balance sheet might look like. As you can see, the unearned revenue will appear on the right-hand side of the balance sheet in the current liabilities column:
Businesses need to create an accounting entry for unearned revenue whenever a customer pays in advance for a good or service which hasn’t been delivered yet. You should also add it to your balance sheet.
Once the goods or service has been provided to the customer, the recorded “unearned revenue” must be changed to “revenue” within your business's accounting books.
Tip: Creating and adjusting a journal entry of unearned revenue will be easier if your business uses the accrual accounting method when recording transactions.
When a customer prepays for a service, you'll need to create an accounting entry for unearned revenue in your books. Using the double-entry accounting method, you'll credit unearned revenue and debit cash when payment is received. This journal entry of unearned revenue shows that your business has received cash but hasn't yet earned it.
Later, once you deliver the goods or services, you'll make a second entry to recategorise this liability as earned revenue. At this point, you'll debit the unearned revenue account and credit your revenue account.
To learn more about revenue recognition rules, check out our guide to AASB 15.
Learn more about adjusting journal entries in accounting.
Unearned revenue can be difficult to track when money is continuously flowing in and out of a business. Why not enlist the help of quality software to track cash flow and generate financial reports automatically?
For help creating balance sheets that can track unearned revenue, consider using QuickBooks Online. This accounting software offers a wide range of financial reporting capabilities, along with expense tracking and invoice features.
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