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Companies usually receive compensation for their products and services after delivery. In some cases, they may also charge the customer simultaneously as they deliver. However, some companies also receive advances for products and services that they will supply later. Accounting standards require companies to record these revenues as unearned revenue. Before discussing the accounting for unearned revenues, it is crucial to understand what it is.
What are Unearned Revenues?
Unearned revenues are proceeds received from customers before delivering products or services. Another name used for these revenues is deferred revenues. In business terms, these revenues can also be called advances or deposits. When customers pay upfront for a product or service, the revenues will remain unearned. Once the company completes its side of the transaction, it becomes earned.
Unearned revenues aren’t actual revenues. Companies record these separately to conform to the accounting standards. Usually, these revenues stay in the accounts for a short time. Unearned revenues do not become a part of the income statement. Since these revenues do not constitute earned proceeds, they stay on the balance sheet. Once the company delivers the products or services, it can report them in the income statement.
Is Unearned Revenue asset or liability?
Unearned revenue in the balance sheet falls under liabilities. Usually, they are short-term obligations and, therefore, constitute current liabilities. Unearned revenues do not fall under the asset category for the company receiving the advance. However, the customer who pays this amount may record it as a prepayment. For that customer, the unearned liability will be an asset. However, they must term it prepayment.
Unearned revenues stay in the balance sheet until the company delivers the product or service. Once it does so, the company can transfer the amount out of the balance sheet. In that case, the unearned revenues will become a part of the income statement as net sales. If the company does not deliver the goods or services, the unearned revenues will continue appearing in the balance sheet.
What are the journal entries for Unearned Revenues?
Companies record the journal entries for unearned revenues in two cases. The first involves the receipt of the advance from the customer. In that event, the company must create a liability in its balance sheet termed unearned revenues. This accounting treatment is crucial under accounting standards. These standards require companies to record revenues only when they meet performance obligations.
When a company receives an advance from a customer, the journal entries will be as below.
| Dr | Cash or bank |
| Cr | Unearned revenues (liability) |
The other journal entries for unearned revenues occur when the company delivers its products or services. As mentioned, the company must transfer this amount to recognize it as sales. In this case, the journal entries will be as below.
| Dr | Unearned revenues (liability) |
| Cr | Revenues |
Example
A company, Red Co., receives $10,000 in cash as advance from a customer. The company promises to deliver its products and services after a month. At the time of this transaction, Red Co. must record the advance as unearned revenues. Therefore, the journal entries will be as below.
| Dr | Cash | $10,000 |
| Cr | Unearned revenues (liability) | $10,000 |
One month later, Red Co. delivers its products to the customer. At that time, the company must transfer the liability to revenues. Thus, the journal entries will be as below.
| Dr | Unearned revenues (liability) | $10,000 |
| Cr | Revenues | $10,000 |
Conclusion
Unearned revenues represent advances from customers for which a company has not delivered goods or services. These revenues constitute liability for the company and are usually short-term. Once the company completes its obligation, the amount gets transferred to the revenues account.
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