What is Unearned Revenue?
Unearned revenue is money got from a client for work-related that has actually not however been performed. That is essentially a prepayment for goods or solutions that will be ceded at a later date. The is most commonly linked with situations where the seller has power end the buyer, or whereby the seller is offering customized products to the buyer. This is advantageous from a cash flow perspective because that the seller, who now has actually the cash to carry out the forced services.
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Examples of Unearned Revenue
Examples the unearned revenue are:
A rent payment made in advance
A services contract payment in advance
A legal retainer paid in advance
Accounting for Unearned Revenue
Unearned revenue is a liability because that the recipient of the payment, therefore the initial entry is a debit to the cash account and a credit to the unearned revenue account. As a company earns the revenue, it reduces the balance in the unearned revenue account (with a debit) and also increases the balance in the revenue account (with a credit). The unearned revenue account is commonly classified together a present liability top top the balance sheet.
If a firm were not to resolve unearned revenue in this manner, and instead acknowledge it every at once, revenues and also profits would originally be overstated, and then understated because that the additional periods throughout which the revenues and also profits should have been recognized. This is also a violation the the matching principle, since revenues are being recognized at once, while related expenses are not being recognized until later periods.
For example, ABC international hires west Plowing to plow that parking lot, and also pays $10,000 in advance, so that Western will provide the company first plowing priority throughout the winter months. At the time of payment, Western has not yet earned the revenue, so it records all $10,000 in an unearned revenue account, using this unearned revenue newspaper entry:
A variation on the revenue recognition approach detailed in the preceding instance is to acknowledge unearned revenue once there is evidence of yes, really usage. Because that example, western Plowing could have instead elected to recognize the unearned revenue based upon the presumption that it will plow for abc 20 times end the course of the winter. Thus, if the plows 5 times throughout the first month that the winter, it can reasonably justification recognizing 25% that the unearned revenue (calculated together 5/20). This method can be an ext precise than right line recognition, but it relies upon the accuracy of the baseline variety of units that are expected come be consumed (which might be incorrect).
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Terms comparable to Unearned Revenue
Unearned revenue is likewise known as prepaid revenue.