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What Is Unearned Revenue?

Unearned Revenue Defined, Explained, & More
Susan Guillory
Susan GuilloryUpdated April 18, 2023
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Unearned revenue is revenue received from a customer before goods or services have been provided. These advance payments can improve your small business’s cash flow, since it now has money to use to produce products or perform the required services. However, it’s important to understand how unearned revenue impacts your company’s books in order to make the most out of this type of income.Here’s a closer look at what unearned income is and how to handle this type of transaction in business accounting. 

Unearned Revenue, Defined

Simply defined, unearned revenue (also called unearned income) is a prepayment for goods and services your business has yet to provide to the customer. This type of revenue provides a business with working capital it can use to fund operations and produce the promised goods or provide promised services.Unearned income is typically used in accrual accounting, which is an accounting method in which revenue or expenses are recorded when a transaction occurs as opposed to when payment is received or made. Unearned income is recorded as a liability (money the business owes) on the business’s balance sheet. The revenue is only recognized after the product or service has been delivered. At that time, an adjusting entry needs to be made.

How Unearned Revenue Works

Businesses can benefit from unearned income because customers pay in advance to receive their products or services. This injection of cash can then be invested into the business. For example a company might use prepayments to purchase more inventory or pay off a small business loanWhite the positive cash flow is nice, it’s important for business owners to remember that unearned income is considered a liability in small business accounting, rather than a revenue. It’s a liability because it’s essentially a debt the company owes the customer. In order to turn unearned revenue into actual revenue, the business must deliver the goods or service to the customer.

Types of Unearned Revenue

Businesses that have unearned revenue often sell subscription-based products or other services that require advanced payments. Common types of unearned income include:
  • Service contract paid in advance
  • Legal retainer paid in advance
  • Prepaid insurance
  • Advance rent payments
  • Annual newspaper or magazine subscription
  • Annual software subscription
  • Airline tickets

Criteria of Unearned Revenue

The Securities and Exchange Commission (SEC) has established several financial reporting criteria, based on Generally Accepted Accounting Principles (GAAP), that public companies must follow in order to recognize revenue. For unearned revenue to become earned revenue on the income statement, there must be:
  • Evidence of an agreement between the business and the customer
  • Completion of delivery of goods or services
  • A predetermined price
  • Collection probability

Where Unearned Revenue Fits on a Balance Sheet

Unearned revenue on a balance sheet is a current liability because it is a debt until the goods or services are delivered to the customer who paid. Generally, it’s assumed that the product or service purchased will be delivered within a year, making it a current (or short-term) liability.If, for any reason, the company is not able to deliver the goods or services, it would owe the customer the money paid, which is why it’s a debt or liability. If a business entered unearned revenue as an asset rather than a liability on the balance sheet, then its total profit would be overstated for this accounting period. In addition, the accounting period in which the revenue is actually earned will then be understated in terms of profit.Once the product or service has been delivered, unearned revenue becomes revenue on the income statement.

Unearned Revenue Accounting

In keeping with double-entry bookkeeping, unearned revenue is always recorded in two accounts. It’s originally entered in the books as a debit to the cash account and as a credit to the unearned revenue account. The credit and debit are the same amount.This journal entry reflects the fact that the business has an influx of cash but that cash has been earned on credit. It is a pre-payment on goods to be delivered or services to be provided.Once the business provides the goods or services, an adjusting entry is made. The unearned revenue account will be debited and the revenues account will be credited the same amount. This means that two journal entries are made for unearned revenue — one when the income is received and and one when the income is earned.Recommended: 5 Popular Small Business Financial Software Options 

Deferred Revenue vs. Unearned Revenue

Unearned revenue and deferred revenue are two different ways to describe the same thing — advance payments a company receives for products or services that are to be delivered or performed in the future. Since this revenue is a prepayment, it is not yet “earned.” It won’t be recorded as revenue on the income statement until the goods or services already paid for have been delivered to the customer. Deferred revenue is sometimes also called deferred income.

Example of Unearned Revenue

To illustrate how unearned income works in the business world, here’s an example. Fictional company XYZ sells a movie streaming service that costs $60 up front for a full year of the service. When the customer pays $60, the owner of XYZ enters $60 as a debit to cash and $60 as a credit to unearned revenue. The full $60 would need to be recorded as unearned service revenue on the company’s balance sheet. As each month of the annual subscription goes by, the monthly portion of this total ($12) can be deducted and recorded as business revenue.

The Takeaway

Unearned revenue is money received by a company for a service or product that has yet to be provided or delivered. These advanced payments are recorded on a company’s balance sheet as a liability because they represent a debt owed to the customer. Once the product or service is delivered, unearned revenue becomes revenue on the income statement.Unearned revenue can benefit your small business because it boosts your company’s cash flow and gives it the cash needed to cover your operational expenses. For unearned income to become earned income, however, your company must deliver the promised product or service to the customer.

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  2. If you are launching a new business or your business is young, lenders will consider your personal credit score. Eventually, though, you’ll want to establish your business credit.
  3. If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.

Frequently Asked Questions

Is unearned revenue considered an asset?
What is an example of unearned revenue?
Where does unearned revenue go on a balance sheet?
Photo credit: iStock/Elena Frolova

About the Author

Susan Guillory

Susan Guillory

Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
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