Unearned Revenue

Unearned revenue is generated when the company has concluded a contract for the supply of goods or services, received money from the clients or imposed obligations on them, but hasn’t performed work yet. It can be considered as an amount paid for a good or service in advance. Due to this kind of payment, an individual or business is liable to provide services to the customer in the future. This liability is due to be settled within twelve months after the reporting period. 

Unearned Revenue explained

Unearned revenue is generally associated with businesses who are selling subscription-based software or services paid for in advance. Among common types of unearned revenue can be mentioned advance rent payments, prepaid insurance, newspaper subscriptions, computer software updates, etc. 

Receiving revenue before the goods or services are delivered or produced can be a good way for a company to cover their operations without taking a loan, for instance, it can order extra goods. 

Recording Unearned Revenue

It's categorized as a current liability sheet because an organization received money without earning it and it will be recognized only when the work will be gradually performed. 

For example, a publishing company sells a two-year subscription to a magazine for $2,400. It is recorded by a business as an increase in unearned revenue. As this income is classified as a liability on the balance sheet, there is no effect on the income statement from this transaction. The publishing company has a liability worth $2,000, which is gradually reduced  by $100 every month, as the company delivers a magazine to a customer’s door every month. So, it recognizes $100 of the unearned revenue every month and increases revenue through it. 

Unearned revenues are considered to be long-term liabilities when obligations must be fulfilled within twelve months or more. 

A business must meet certain requirements that outline the specific conditions under which revenue is recognized. It is not allowed to recognize revenue until they are taken into consideration. 

These criteria include collection probability, the ability to make a reasonable estimate of an amount for the allowance for doubtful accounts, completion of delivery, etc. 

Example

A software development company creates custom solutions for a business and offers a wide variety of computer software programs. A customer of this company should prepay for an annual service subscription. In this situation, the revenue received is considered unearned revenue. 

At the end of 2021, $50 million worth of the company's revenue is unearned. The company records unearned revenue as a short-term liability on the balance sheet as it expects that all obligations will be paid within twelve months.