Assume that ABC Service Co. receives $24,000 on December 31, 2021 in exchange for promising to provide the client with services for the year January 1 through December 31, 2022. Therefore, ABC’s balance sheet as of December 31, 2021 must report a liability such as Unearned Revenues for $24,000. During 2022 ABC must move $2,000 each month from the liability account on its balance sheet to a revenue account on its income statement. For most businesses where prepayment terms are 12 months or less, unearned revenue is treated as a current liability on the balance sheet. Unearned revenue is a liability that gets created on the balance sheet when your company receives payment in advance. You can think of it like a promise or IOU to provide a product or service at a later date. Since prepaid revenue is a liability for the business, its initial entry is a credit to an unearned revenue account and a debit to the cash account.
1) The company has an agreement with the customer to provide goods or services. Unearned revenue presents itself to a small business as an opportunity to boost the amount of working capital for rounding up its portfolios. Through this, small businesses can cover their day-to-day operations what is unearned revenue without going for a loan. Our library of 200+ lessons will teach you exactly what you need to know to use it at work tomorrow. Most large corporations use the accrual accounting method and are required to follow GAAP . But let’s look at a practical example to help solidify the concept.
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For example, it will allow them to break up their project payments into smaller installments. Say, for example, you can have an agreement with your supplier that if you pay for the services a year ahead, a certain percentage of discount will be given. Allocate that amount on your books to recognize the revenue once the business obligation has been satisfied. On July 1, Magazine Inc received a $60 payment for a one-year subscription from a new customer.
It means you will recognize revenue on your revenue statement in the period you realize and earn it, not necessarily when you received it. Companies are turning to smarter, AI-oriented solutions for recognizing and reporting revenue, such as ProfitWell Recognized. For example, XYZ Company sells insurance, and their customers routinely pre-pay for 12 months of insurance at a time.
How to calculate unearned revenue (with examples)
ABC Company receives $25,000 for 1,000 pallets to be delivered in two months. This entry books the $25,000 received as unearned revenue because the company has not produced or provided the pallets yet. Unearned revenue is recorded as a liability on the balance sheet. Once the good or service has actually been provided, it is then recorded as sales revenue on the income statement. The Financial Accounting Standards Board and the International Accounting Standards Board are two independent standard-setting entities in the field of accounting.