Every business will have to deal with unearned revenue at some point or another. As the owner of a small business, it is up to you to determine how best to manage and report unearned revenue within your accounting journals.
Here is everything you need to know about unearned revenue and how it affects your small business.
Unearned revenue refers to the money small businesses collect from customers for their products or services that have not yet been provided. In simple terms, it is the prepaid revenue from the customer to the business for goods or services that will be supplied in the future.
In accounting, unearned revenue has its own account, which can be found on the business’s balance sheet. It is classified as a current liability, as it is a debt owed to your customer. Once the delivery has been completed, and your business has finally provided the prepaid goods or services, the unearned revenue is converted into revenue on the balance sheet.
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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.
Your business might record unearned revenue in its accounting books for a number of reasons. Such recording of unearned revenue might happen in cases of:
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.
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.
A business will need to record unearned revenue in its accounting journals and balance sheet when a customer has paid in advance for a good or service, which you have not yet delivered. Once they have been provided to the customer, the recorded unearned revenue must be changed to revenue within your business’s accounting books.
Creating and adjusting journal entries for unearned revenue will be easier if your business uses the accrual accounting method when recording transactions.
When a customer prepays for a service, your business will need to adjust the unearned revenue balance sheet and journal entries. Your business will need to credit one account and debit another account with corresponding amounts, using the double-entry accounting method to do so.
Unearned revenue should be entered into your journal as a credit to the unearned revenue account, and a debit to the cash account. This journal entry illustrates that the business has received cash for a service, but it has been earned on credit, a prepayment for future goods or services rendered.
Once the goods or services are rendered, and the 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 the unearned revenue account and credit the service revenues account for the corresponding amount.
You will, therefore, need to make two double-entries in the business’s records when it comes to unearned revenue: once when it is received and again when it is earned.
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.
To learn more revenue recognition rules have a look our guide to AASB 15.
Accounting unearned revenue within a business can be a tricky thing 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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