Unearned revenue, also known as deferred revenue, is an advance payment a company receives for goods or services that have not yet been delivered or rendered. Several kinds of businesses record unearned revenue.

Below, we’ll walk through how to record unearned revenue, how unearned revenue impacts financial statements and balance sheets, and examples of unearned revenue.

What’s in this article?

• How to record unearned revenue
  
• Is unearned revenue a liability?
  
• How does unearned revenue impact financial statements and balance sheets?
  
• Unearned revenue vs. deferred revenue
  
• Examples of unearned revenue
  

How to record unearned revenue

When a company is paid for services or products that have not yet been delivered, these payments must be recorded as unearned revenue. Since the revenue has not yet been earned, it cannot be reported as income at that time. Instead, the accountant records a debit to the cash account, increasing assets, and a credit to the unearned revenue account, which increases liability. This reflects receiving cash that the company is obligated to earn by delivering those goods or services.

As the company delivers the goods or performs the service, it recognizes a portion of the unearned revenue as earned revenue. This process decreases liability and increases revenue, reflecting the fulfillment of the obligation. Each time a portion of the service or product is delivered, the accountant makes a journal entry moving the appropriate amount from unearned revenue to a revenue account on the income statement.

The company’s financial statements reflect the timing of income recognition, which is defined by the matching principle in accounting. This means that expenses should be matched with the revenue they help generate to provide a clearer look at financial performance.

Is unearned revenue a liability?

Yes, unearned revenue is considered a liability on a company’s balance sheet. It represents money received from customers for goods or services that have not yet been delivered or performed. As such, it constitutes an obligation for the company to provide these goods or services in the future. Until the company fulfills this obligation, the amount is recorded as a liability. Once the service or product is delivered, the liability is removed, and the payment is recognized as revenue.

How does unearned revenue impact financial statements and balance sheets?

Unearned revenue affects a business’s balance sheet, income statement, cash flow statement, and financial analysis. Let’s take a closer look.

Balance sheet

• Current liabilities: Unearned revenue is classified as a current liability if the goods or services are expected to be delivered within one year from the date of the transaction. This liability reflects the company’s obligation to deliver products or services in the future.

• Assets: When unearned revenue is first recorded, it is usually accompanied by an increase in cash or receivables, increasing the total assets on the balance sheet.

Income statement

• Revenue recognition: When a company earns unearned revenue, that amount is moved from a liability on the balance sheet to revenue on the income statement. This move happens over the period the goods or services are provided, and the timing of revenue recognition can affect the company’s profitability reporting. If a large amount of revenue is received but not earned within a financial period, it might show lower profitability despite higher cash flow.
  

Cash flow statement

• Operating cash flows: Unearned revenue increases the cash flow from operating activities, as it is cash received before the actual sale is recognized.

• Financial ratios: Unearned revenue can affect financial ratios such as the current ratio (a liquidity ratio) and the debt-to-equity ratio. Higher unearned revenue can increase liability, potentially lowering the current ratio and increasing the debt-to-equity ratio.

Financial analysis

• Liquidity analysis: Analysts look at unearned revenue in the context of liquidity management. A company with high unearned revenue must make sure it can deliver on its obligations without affecting its operational cash flow.

• Earnings quality: Unearned revenue helps assess the quality of earnings. High unearned revenue indicates the company has cash up front, which can provide financial stability, but it also signifies a commitment to deliver, which can impact future earnings if not met.

Unearned revenue vs. deferred revenue

Unearned revenue and deferred revenue both refer to the same accounting concept: advance payments a company receives for products or services that have not yet been delivered or performed. While the terms are synonymous, there can be subtle differences in how they are used in practice.

Unearned revenue

• Unearned revenue is sometimes used more specifically to refer to the short-term portion of these liabilities expected to be fulfilled within one year.

• Unearned revenue is typically presented as a single line item under current liabilities, as it’s expected to be recognized as revenue within the next year.

Deferred revenue

• This term is often used to more broadly encompass both short-term (current) and long-term liabilities related to advance payments.

• Deferred revenue can be split into current and long-term liabilities on the balance sheet depending on the timing of the obligation.

• The Financial Accounting Standards Board (FASB) primarily uses the term “deferred revenue.”

The distinction between the terms is more a matter of preference and usage than a fundamental difference in accounting. Both unearned and deferred revenue represent liabilities that are gradually recognized as revenue as the company meets its obligations.

Examples of unearned vs. deferred revenue

A company receives a three-year subscription payment up front:

• The portion expected to be earned within one year would be classified as unearned revenue (current liability).

• The remaining portion would be considered deferred revenue (long-term liability).

A landlord receives rent payments in advance:

• These would typically be classified as unearned revenue (current liability) because they’ll be earned as the rental period progresses.
  

Examples of unearned revenue

Unearned revenue is present across industries and business models. Here are some examples of unearned revenue in different kinds of businesses.

Subscription services

• Magazines and newspapers: Subscribers pay in advance for their subscriptions. The publication recognizes revenue as each issue is delivered.

• Streaming services: Services such as Netflix or Spotify collect payments for monthly subscriptions in advance, recognizing revenue as access is provided over the month.

Software and technology

• Software licenses: Companies that sell software-as-a-service (SaaS) products are often paid in advance for annual subscriptions. Revenue is recognized each month as the service is provided.

• Maintenance contracts: Payments for future software support and updates are recognized as the services are rendered.

Retail

• Gift cards and vouchers: Retailers are paid when gift cards are purchased, but they do not recognize the revenue until the cards are redeemed.
  

Insurance

• Premiums: Insurance companies collect premiums for coverage that extends into the future. Revenue is earned proportionally over the coverage period.
  

Real estate and rentals

• Advance rent payments: Landlords collect rent in advance, both at the beginning of each month for that month’s occupancy and at the time of lease signing.
  

Construction

• Contracts: Payments received before long-term construction projects are completed are recognized over time as work progresses.
  

Live events

• Ticket sales: Revenue from tickets sold for concerts, sporting events, or theater productions is recognized on the date of the event, not when tickets are sold.
  

Legal and consulting services

• Retainers: Law firms and consultants are paid retainers for future services that will be recognized as revenue as the services are provided.
  

Travel and hospitality

• Airline tickets: Airlines receive payment for tickets sold, then recognize it as revenue on the date of the flight.

• Hotel bookings: Payments for future hotel stays are recognized as revenue when the stay occurs.

Educational services

• Tuition: Tuition fees paid in advance for a semester or school year are recognized as revenue over the academic period.