Is unearned revenue a liability? In essence, yes, but a temporary one!<\/p>\n\n\n\n
\u0410lso known as unearned income and deferred revenue, this form of advance payment refers to the prepayment received by service providers or sellers before they provide or ship out the paid-for service or product at a later date.<\/p>\n\n\n\n
However, since the transaction still needs to be completed, the service and\/or product provider takes on the same amount of liability as the revenue they receive, which will be eliminated once the goods and\/or services are delivered.<\/p>\n\n\n\n
Keep on reading as we explore the topic in depth below!<\/p>\n\n\n\n
Deferred income is the amount of advance payment consumers provide<\/strong> to companies offering services and products with pending deliveries or provisions.<\/p>\n\n\n\n Common examples of unearned revenue include prepaid insurance policies, legal retainers, transportation tickets, magazine subscriptions, car pre-orders, etc.<\/p>\n\n\n\n However, until the service is provided, the business is essentially in debt to the customer<\/strong>, which is why such income is recorded as a liability.<\/p>\n\n\n\n Many modern industries take payments in advance from customers, using this cash flow for any number of purposes and activities, including preparing the goods or services to be delivered, covering their loan interests, paying their operational costs, etc.<\/p>\n\n\n\n Some of the most common examples include and are not limited to the following:<\/p>\n\n\n\n Operating with unearned income is typically preferred by small businesses as they most often have to cover the production cost of the ordered item.<\/strong> <\/p>\n\n\n\n Also, they often customize the order, so receiving a prepayment allows them to buy the exact raw materials they need. However, the biggest benefit is the revenue forecast<\/strong> they get, as they can easily calculate their future revenue based on their orders.<\/p>\n\n\n\n From an accounting point of view, advance payments must always be entered as liabilities in order to keep the ledgers balanced.<\/strong> If you were to enter such revenue as an asset, the profits would be overstated for the specific accounting period.<\/p>\n\n\n\n Therefore, to avoid violating the accounting equation<\/strong>\u2014Assets = Liabilities + Equity<\/em>\u2014payments for undelivered products and services become liabilities. After all, businesses that fail to provide the service are indebted to the customer and have to repay them. Furthermore, the customer has the right to cancel the contract in most cases.<\/p>\n\n\n\n Once a company receives payment for services or goods to be provided, it enters it into its <\/strong>deferred income account<\/strong> as a liability.<\/strong> However, some companies also keep a cash flow statement that records such payments as they are used for daily operations.<\/p>\n\n\n\n Any and all revenue entries previously recognized as liabilities will be re-recorded as actual revenue<\/strong> when the actual delivery of goods and\/or services happens. Namely, the company truly earns said revenue after the transaction is closed.<\/p>\n\n\n\n For instance, a company that sold Christmas gifts ahead of time, which are to be delivered in December, will not record the sale on September\u2019s, October\u2019s, or November\u2019s monthly income statement, but rather in December once the sale is concluded.<\/p>\n\n\n\n However, in the case of a subscription service paid in total but provided on a staggered monthly basis, companies will gradually reduce their unearned revenue sheet while increasing their actual revenue by the same amount each month.<\/p>\n\n\n\n Note:<\/strong> In most cases, unearned revenues are short-term liabilities since businesses fulfill their obligations within a year of receiving payment.<\/p>\n\n\n\n Is unearned revenue a liability? In essence, yes, but a …<\/p>\nWhich Industries Have Mostly Unearned Income?<\/strong><\/h2>\n\n\n\n
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Why Is Unearned Revenue a Liability?<\/strong><\/h2>\n\n\n\n
How Is Unearned Income Recorded?<\/strong><\/h2>\n\n\n\n
Key Takeaways<\/strong><\/h2>\n\n\n\n
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