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What Is Unearned Revenue? A Definition and Examples for Small Businesses

is unearned revenue a liability

If the company failed to deliver, it would still owe that money to the customer so it cannot be recorded as revenue just yet. After delivery, the payment switches from liability to revenue. Once deferred revenue recognition takes place, it comes off the balance sheet. In accrual accounting, assets need equal liabilities, in the same period. This is money paid to a business in advance, before it actually provides goods or services to a client.

Positive cash flow can keep a small business’s operations thriving. However, a business owner must ensure the timely delivery of products to its consumers to keep transactions steady and drive customer retention. This is why it is crucial to recognize unearned revenue as a liability, not as revenue. Unearned revenues are recognized as the liability account in the current liability section of the balance sheet in the financial statements. Unearned revenue, also calls deferred revenues, is a liability account because it represents the revenue that is not yet earned. After all, the services or products are not yet delivered to the customer.

Resources for Your Growing Business

Since service is owed, it is considered a short-term or long-term liability. Once revenue recognition occurs, it is earned revenue and becomes income. On January 1st, to recognize the increase in your cash position, you debit your cash account $300 while crediting your unearned revenue account to show that you owe your client the services.

  • If the company does not deliver the goods or services, the funds will be due back to the customer.
  • You just gained $2,000 in your cash account that you can use to keep your business operations up and running!
  • She received her Bachelor’s degree in Business Administration from the University of Minnesota.
  • It can be thought of as a “prepayment” for goods or services that a person or company is expected to supply to the purchaser at a later date.
  • This is why unearned revenue is recorded as an equal decrease in unearned revenue (a liability account) and increase in revenue (an asset account).

This will direct the money out of the account and recognize it as revenue. More specifically, the seller (i.e. the company) is the party with the unmet obligation instead of is unearned revenue a liability the buyer (i.e. the customer that already issued the cash payment). Unearned revenue is treated as a liability on the balance sheet because the transaction is incomplete.

Is Equipment a Current Asset?

Unearned income is money a company receives from a client before the delivery of an item or service. Unearned income is reported on a balance sheet as a debit to the cash account and a credit to the unearned revenue account. Once the unearned income is classified, the next step is to record the transaction in the company’s financial records.

When a customer pays for products or services in advance of their receipt, this payment is recorded by a business as unearned revenue. Also referred to as “advance payments” or “deferred revenue,” unearned revenue is mainly used in accrual accounting. Due to the advanced nature of the payment, the seller has a liability until the good or service has been delivered. As a result, for accounting purposes the revenue is only recognized after the product or service has been delivered, and the payment received.

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