Unearned Revenue Accounting

Overview

Unearned revenue is the money that the company receives in advance for the goods or services that it has not delivered or performed yet. In short, it is the revenue that the company has not earned yet; hence, the word “unearned revenue”

Under the accrual basis of accounting, revenue should only be recognized when it is earned, not when the payment is received. Likewise, the unearned revenue is a liability that the company records for the money that it receives in advance.

Hence, the unearned revenue account represents the obligation that the company owes to its customers. The amount in this account will be transferred to revenue when the company fulfills its obligation by delivering goods or providing services to its customers.

Unearned revenue journal entry

The company can make the unearned revenue journal entry by debiting the cash account and crediting the unearned revenue account.

Account Debit Credit
Cash xxx
Unearned revenue xxx

Unearned revenue is a liability account which its normal balance is on the credit side. The amount of unearned revenue in this journal entry represents the obligation that the company has yet to perform.

Once, the company fulfills its obligation by providing the goods or services to the customers, it can make the journal entry to transfer the unearned revenue to the revenue as below.

Account Debit Credit
Unearned revenue xxx
Revenue xxx

In this journal entry, the company recognizes the revenue during the period as well as eliminates the liability that it has recorded when it received the advance payment from the customers.

Unearned revenue example

For example, on June 29, 2020, the company ABC Ltd. received an advance payment of $4,500 from its client for the three-month service that the company will perform in July, August, and September 2020.

In this case, the company ABC Ltd. needs to account for the $4,500 advance payment that is received from the client as the unearned revenue because it has not performed service for the client yet.

Hence, on June 29, 2020, ABC Ltd. needs to make the unearned revenue journal entry as below:

Account Debit Credit
Cash 4,500
Unearned service revenue 4,500

In this journal entry, the $4,500 is recorded as a liability because the company ABC Ltd. has the performance obligation to provide the service to its client in the next three months. Likewise, both asset (cash) and liability (unearned service revenue) increase by $4,500 on June 29, 2020.

After ABC Ltd. performs the service in July 2020, it can recognize $1,500 (4,500/3) as revenue in the July 31 adjusting entry as below:

Account Debit Credit
Unearned service revenue 1,500
Service revenue 1,500

Likewise, after the July 31 adjusting entry, the remaining balance of unearned service revenue will be $3,000 (4,500 – 1,500). This balance will be zero at the end of September 2020 when the company completes the service it owes to the client.