What is Unearned Revenue?

Every business will have to deal with unearned revenue at some point or another. Small business owners must determine how best to manage and report unearned revenue within their accounting journals.

Below you’ll find everything you need to know about unearned revenue and how it affects your small business. 

Unearned Revenue Defined

Unearned revenue refers to the money small businesses collect from customers for a or service that has not yet been provided. In simple terms, unearned revenue is the prepaid revenue from a customer to a business for goods or services that will be supplied in the future.

Criteria for Unearned Revenue

So, what type of account is unearned revenue, exactly? In accounting, unearned revenue has its own account, which can be found on the business’s balance sheet. Funds in an unearned revenue account are classified as a current liability – in other words, a debt owed by a business to a customer. Once a delivery has been completed and your business has finally provided prepaid goods or services to your customer, unearned revenue can be converted into revenue on your balance sheet.

So what Is Unearned Revenue and Why Is It Important?

Your business needs to record unearned revenue to account for the money it's received but not yet earned. Recording unearned revenue is important because your company can't account for it until you've provided your products or services to a paying customer. It's important to rely on accounting software like QuickBooks Online to keep track of your unearned revenue so that you can generate accurate and timely financial statements each accounting period.

Unearned Revenue vs Deferred Revenue

Unearned revenue and deferred revenue are the same things, as are deferred income and unpaid income. These are are all various ways of referring to unearned revenue in accounting.

Examples of Unearned Revenue

Unearned revenue is a liability, so your business may record unearned revenue in its accounting books for a number of reasons:

• Magazine and journal subscriptions
• Subscription boxes and services
• Prepaid insurance
• Phone plans
• Rent

As an example of unearned revenue, 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 from which 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, since all money received accounts for the six mystery boxes that have been paid for. 

Unearned Revenue on the Balance Sheet

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.

How to Record Unearned Revenue

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 they have not yet delivered. Once it’s been provided to the customer, unearned revenue is recorded and then changed to normal revenue within a business’s accounting books.

Creating and adjusting journal entries for unearned revenue will be easier if your business uses the accrual accounting method, of which the revenue recognition principle is a cornerstone. 

Unearned Revenue Journal Entries

At this point, you may be wondering how to calculate unearned revenue correctly. When a customer prepays for a service, your business will need to adjust its unearned revenue balance sheet and journal entries. Your business will need to credit one account and debit another account with the correct amounts using the double-entry accounting method.

Unearned revenue should be entered into your journal as a credit to the unearned revenue account and as a debit to the cash account. This journal entry illustrates that your business has received cash for its service that is earned on credit and considered a prepayment for future goods or services rendered.

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 account while crediting its service revenues account for the appropriate amount.

You will, therefore, need to make two double-entries in your business’s records when it comes to unearned revenue: once when it is received, and again when it is earned.

You’ll see an example of the two journal entries your business will need to create below when recording unearned revenue. Taking the previous example from above, Beeker’s Mystery Boxes will record its transactions with James in their accounting journals.

QuickBooks Online and Balance Sheets

Accounting for unearned revenue during an account period can be a tricky thing to track when money is always flowing in and out of a business. Why not enlist the help of quality software like QuickBooks Online to track cash flow and generate financial reports automatically?

For help creating balance sheets that can track unearned revenue, consider using QuickBooks Online. QuickBooks offers a wide range of financial reporting capabilities, along with expense tracking and invoice features.