Unearned or deferred revenue is money a business receives in advance of providing a product or service. Funds are recorded as a liability rather than sales revenue because the unearned revenue obligates the business to provide the product or service, but at some point the cash may need to be refunded. Unearned revenue is more common in industries that deal with intangibles and less common in industries that focus on products.
In double-entry accounting, unearned revenue debits cash and credits an unearned liability account. As unearned revenue becomes earned, an adjusting entry reduces the unearned liability account by debiting it for the revenue earned and increases sales or services revenues with a corresponding credit amount. If the unearned revenue is from a down payment, the initial debit and credit entries are the same. The only difference is that the down payment amount gets adjusted all at once when the product or service is delivered.
Service-based industries that contract with buyers to perform regular maintenance or routine service often charge in advance and as a result have unearned revenue. Exterior service providers include lawn care, swimming pool, lawn irrigation systems, window washing and chimney cleaning and maintenance. Interior service providers include furnace repair and maintenance, ductwork cleaning and household cleaning services. Service contracts can also include those you purchase but may never use. Extended service contracts for appliances and electronics sell for a specific price, cover specific repairs and have a specific time frame within which you can get free or reduced price service.
Any industry that provides goods or services on a subscription or membership basis - and has a refund policy for early cancellations - brings in unearned revenue. Examples include the magazine and newspaper publishing industry, cloud-based software providers and fitness centers. Options for recording subscription-based prepayments can include recording the prepayment in monthly installments as the subscription progresses or waiting to record the revenue until the subscription finishes.
The construction industry, furniture manufacturers or any industry that manufactures custom products often require a percentage of the total sale as a down payment. Service providers may also require a down payment if the service is an intangible or requires purchasing supplies such as painting, roofing or renting a meeting space. The final adjusting entry to convert the liability to sales can be made after completing the entire job or as the business purchases necessary supplies.