On the surface, the term "unearned revenue" may seem contradictory or confusing. You may wonder how your business can receive revenue it hasn't earned, or who would be silly enough to pay for something they haven't received. However, unearned revenue is a legitimate business accounting term, and if you work in the business field, you may need to understand what it means and how it applies to your business.
The balance sheet is an important financial statement used by many businesses. It reports your company's economic circumstances as of a specific time. The balance sheet is broken down into three sections. The first section shows the assets, or resources, belonging to your company. The second section shows your liabilities, or debts, and the third section shows the equity, or investment amount, of the owners or stockholders. The total of the first section, assets, must always equal the total of the second and third sections together, liabilities and equity.
Revenue is the business income you earn. Depending on your business type, revenue might come from product sales or services rendered, or it might come from a combination of both. Revenue is reported on your income statement, which is the other most commonly used business financial statement. The income statement shows your revenue, followed by your business expenses. Expenses are subtracted from revenue to calculate your net income or loss.
Unearned revenue is business income that you have received but not yet earned. Insurance premiums, rent, membership fees or maintenance contract fees are examples of unearned revenue when they are received in advance of the customer receiving the agreed-upon benefit. Subscription fees are often unearned revenue. If you charge a subscription fee for a publication or something else on an annual or other basis, the amount of the subscription fee that covers future issues or services is unearned revenue.
Recording Unearned Revenue
Because unearned revenue represents income you have received for which you have not yet provided a product or service, your company has a liability to provide that product or service. In the case of subscription revenue, you have a liability to provide the publication, membership rights, or other items or services to which your customer has subscribed. Therefore, when you receive the revenue, you must reflect both the receipt of funds and the liability to your customer on your financial statements. You do this by recording a debit to cash or another applicable asset account and a credit to unearned revenue for the amount you received. As the subscription is used up on a monthly or other basis, you record a debit to unearned revenue and a credit to revenue. This adjusting entry recognizes the reduction of your liability and the increase in your revenue because you have now provided the subscription that was previously paid for in advance.