If your small business provides professional services and sells tickets for the services, those sales count as unearned revenue. This means they represent prepayments made for your services that you can’t record as revenue until you fulfill them at a later time. Why can’t you count them right away? Accounting rules for revenue recognition classify ticket sales as a benefit — or proxy for revenue — that you should record as a liability until redemption. That unearned revenue obligates your business to hold the event or perform the service associated with those tickets at some point in the future. Once customers or clients redeem their holdings, you can recognize those ticket sales as revenue that cancels out the earlier recorded liability.
Understanding Revenue Recognition Accounting
Revenue recognition, a generally accepted accounting principle (GAAP), uses two methods for noting revenue: cash basis and accrual basis. Simple and intuitive, cash basis stipulates recognizing revenue whenever you receive a cash payment. Keep in mind ,that recognizing unearned revenue this way might potentially distort your financial statements, as it doesn’t show whether you still have an obligation to perform the service. Because of this, using the accrual basis better reflects the business reality of ticket prepayments. It provides you a way to recognize the revenue only when you actually earn it. The accrual basis method also benefits your business by letting you list the redeemed ticket revenue alongside the service-associated expenses related to its redemption, regardless of your actual cash receipts.
Adding Liability Accounts for Unearned Revenue
When you use the accrual basis revenue recognition method and receive cash prepayments from ticket sales, you debit your cash account for the ticket sale amount. You then credit that same amount to a liability account called unearned revenue. This liability account exists because you now have an obligation to ticket holders, requiring that you carry out the event or perform the service before you actually earn the revenue. If ticket holders don’t redeem them by the end of your current accounting period, you can’t recognize any revenue from the sales during that period, despite the recorded ticket sales and increased cash holdings. Consider accounting software such as QuickBooks Online to help with the process and provide you with targeted reports so you can better track your small business financials.
Revenue Recognition and Ticket Redemption
While you earn ticket sales revenue when you hold the event or perform the service, you also incur related expenses. With that in mind, GAAP methods for revenue recognition require that you recognize revenue in the same period in which the expenses occur. This means that once you complete services for ticket holders, you can fully recognize the amount of ticket sales while matching with related expenses. You do this by debiting the liability account where you recorded the unearned revenue and then crediting your revenue account for the same amount. This process effectively cancels out the liability of unearned revenue, whether individual ticket redemption occurs all at once or over a period of time. Keep in mind if you cancel services for the purchased tickets, you must also cancel the entries in both your cash account and liability account.
Benefits of Revenue Recognition Compliance
While it might seem counterintuitive to consider future sales a liability, compliance with revenue recognition rules ensures you can accurately interpret the details of each business transaction. When you can easily see the differences between cash prepayments, unearned revenue, and recognized revenue, you can use that clarity to further fine-tune your processes to achieve target financial results. Having ticket sale funds set aside ensures you have the cash on hand to pay back individual customers who want refunds or all the ticket holders if you cancel events.
While tickets sales for events or services can help boost your bottom line, revenue recognition rules mean you can’t count that unearned revenue until you complete your obligation. This ensures that both you and your customers benefit from the exchange and keeps your business in compliance with GAAP rules. Using an accounting system, such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.