An unearned fee in accounting is money a business collects from a customer up front for services the company has yet to perform, such as a prepaid annual membership. If your small business collects unearned fees, you must record the fees initially as a liability on the balance sheet. As you complete the services for those fees, the fees become earned revenue, which you record on the income statement.
Revenue increases your profit on the income statement. The revenue recognition principle under generally accepted accounting principles, or GAAP, requires a business to record revenue when it completes a service or sells a product, regardless of when payment occurs. This means a small business must record its unearned fees as revenue in portions as it earns the revenue, not when it receives the cash. For example, you would record an unearned fee for an annual membership as revenue in 12 equal portions at the end of each month.
Reporting Unearned Fees
When your small business collects an unearned fee, report the amount initially as unearned revenue in the liabilities section of your balance sheet. Liabilities are amounts you owe another party. Also, increase your cash account in the assets section of your balance sheet. For example, if you collect $480 for an annual membership, report $480 as unearned revenue in the liabilities section of your balance sheet and increase the cash account by $480. This shows you collected $480 and owe your customer $480 in services.
Calculation of Earned Revenue
As each month passes and your small business completes a portion of the services for which your customer paid you, you must report that portion as revenue. If you complete the same amount of services each month, divide the unearned fees you collected by the number of months for which you owe the customer your services, to determine the monthly revenue. For example, if you collected $480 for a prepaid annual membership, divide $480 by 12 to get $40 per month in revenue.
Reporting Unearned Fees as Revenue
At the end of each month, increase your revenue account on your income statement by the portion of unearned fees that you have earned as revenue. Decrease your unearned revenue account by the same amount. The decrease in unearned revenue reduces the amount of services you still owe your customer. For example, if you earned $40 in revenue during a month as a portion of the unearned fees you collected, increase your revenue account by $40 and decrease your unearned revenue account by $40.
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- Internal Revenue Service. "Unearned Income." Accessed Nov. 22, 2019.
- Social Security Administration. "What is 'unearned income'?" Accessed Nov. 22, 2019.
- Internal Revenue Service. "Publication 590-A (2018), Contributions to Individual Retirement Arrangements (IRAs)." Accessed Nov. 22, 2019.
- Internal Revenue Service. "What is Earned Income?" Accessed Nov. 22, 2019.
- 26 U.S.C. 21 - Federal Insurance Contributions Act. "Section 2102: Deduction of tax from wages." Accessed Nov. 22, 2019.
- Internal Revenue Service. "Publication 550 (2018), Investment Income and Expenses." Accessed Nov. 22, 2019.