Almost all accounting is done on either a cash basis or an accrual basis. Cash basis accounting means that costs and revenues are recorded on the accounts when cash is either paid out or received for those transactions. In contrast, accrual basis accounting means that costs and revenues are recorded on the accounts at the times of their occurrences. Cash received for services not yet rendered by the business is considered revenue under cash basis. Accrual basis accounting, though, labels it unearned revenue.
Revenue recognition refers to the set of criteria used to determine when the existence of revenues should be recognized by being recorded on the accounts. Under cash basis, this is when cash is received by the business. Under accrual basis, revenue is recognized only when it is earned and realizable. Earned means that the transaction producing the revenues has been completed, while realizable means that the revenue has a reasonable chance of being collected by the business.
Unearned revenue is a phenomenon in accrual basis accounting when a business has received payment for goods or services that it has not yet rendered to its customers. One example of unearned revenues would be prepayments on a long-term contract. Unearned revenue is listed on the business's balance sheet as a current liability, not a contra asset.
Contra assets are asset accounts that have a credit balance rather than the normal debit balance. For assets, a debit balance means that it has positive value, while a credit balance has negative value. For example, a building account with a credit balance is impossible because it implies that the business somehow has negative buildings, which is a nonsensical implication. Unearned revenue is not a contra asset because the business has no ownership claim to the sum that it represents.
Current liabilities are short-term liabilities, meaning that they have an expected lifespan of less than one year. Liabilities are a business's economic obligations to other entities incurred through its past transactions. For example, long-term debt is a liability because the business is obligated to repay principal and interest over time due to its usage of the borrowed monies. Unearned revenue is considered a liability because the business has an obligation to provide the goods or services represented by the sum paid to it.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.