If you’re in the business world, you know that there are a lot of different types of revenue. Some businesses bring in money through earned income, while others receive unearned income. So, what exactly is unearned revenue? And more importantly, is unearned revenue a current liability?
Simply put, unearned revenue is money that has been received by a company but hasn’t been delivered. This can happen when customers pay for goods or services upfront but don’t receive them until later. In this case, the company has to hold onto the money until it can provide the product or service to the customer. Only then can they “earn” the money.
So is unearned revenue a current liability? Technically speaking, yes, unearned revenue is considered a current liability on a company’s balance sheet. However, it’s important to note that not all liabilities are created equal. Unearned income isn’t necessarily bad for your business. In fact, it can actually be quite helpful in cash flow planning and forecasting
Is Unearned Revenue a Current Liability?
Unearned Revenue is a liability. According to GAAP, all uncollected amounts should be reported as liabilities.
A liability is an obligation of a company that arises during the course of business. This can be anything from a 30-year mortgage on an office building to the bills that need to be paid in the next 30 days. A company needs to manage its liabilities effectively to maintain financial stability and solvency.
Now, you may be thinking: How can a revenue stream be a liability for a company? To understand this, you need to understand what the term “unearned” means.
What Is Unearned Revenue?
Unearned revenue represents money that has been paid by a customer, but which has not yet been delivered. This money is typically held in escrow until the work is completed, at which point it is transferred to the company’s bank account.
This type of revenue is also known as deferred revenue or advanced payment.
When a customer pays for a service or a product in advance, it is referred to as “unearned” or “prepaid” revenue. It is recorded as a liability on the balance sheet because it is considered a debt owed to the customer.
Once the service or product is delivered, the “debt” becomes revenue on the income statement.
Early payments allow a company to increase its cash flow that can be used for other business expenses.
Understanding Unearned Revenue
The most common source of unearned revenues is from companies that sell products or services that require a subscription fee or prepayment.
Examples of unearned revenue are insurance premiums, legal retainers, plane tickets, newspapers, and computer software.
Getting paid before service is completed can be very beneficial. The earlier you receive payment, the more money you can use to pay off debt, purchase more inventory, and keep things running.
Unearned revenue is considered a liability because the company has not yet provided the services that the customer has paid for. This money is still owed to the customer and should be listed as such until the debt is repaid.
When Do You Record Unearned Revenue?
You should record advanced payments as soon as you receive them. In your company’s balance sheet, prepayments are recorded as a liability. Therefore, you will debit the cash entry and credit unearned revenue under current liabilities.
After you deliver the product or service, you will adjust the entry and record it as revenue. At this point, you will debit unearned revenue and credit revenue.
Receiving unearned revenue means that you have received payments for products or services before they have been delivered. This creates a liability, as the customer has paid for something that has not yet been provided. Over time, however, this liability becomes an asset, as you deliver the product or service.
Unearned revenues are short-term liabilities unless you deliver the service a year or more after receiving the payment.
Recording Unearned Revenue on the Balance Sheet
Unearned revenue is shown as a liability on a balance sheet since it shows items that are still owed to the client. As the product or service is delivered over time, this liability becomes revenue on the income statement.
Let’s say a publisher charges $1,200 for a one-year subscription. The $1,200 is recorded as an increase in cash and an increase in unearned revenue.
If it’s a monthly magazine, as each periodical is delivered every month, the liability or unearned revenue is reduced by $100 ($1,200 divided by 12 months) while revenue is increased by the same amount.
While unearned revenue is disclosed as a current liability on a balance sheet, this changes if advance payments are made for 12 months or more. In such cases, unearned revenue is recorded as a long-term liability.
Unearned Revenue Reporting Requirements
If a company does not meet certain SEC requirements, then it must defer recognizing revenue from that sale.
To recognize revenue from sales, companies must have reasonable evidence that a sale was completed, that the product was delivered, and that the customer has paid for it.
Example of Unearned Revenue
At the end of 2Q in 2020, Morningstar had $287 million in unearned revenue. The company classified it as a short-term liability — meaning that it expected to be paid over one year.
The change in unearned revenues can be a clue to whether the company will be profitable in the future. However, it could also be due to a change in how the company is doing business.
Although the increase in unbilled receivables provides insight into potential future growth, this growth could be the result of a change in how the company collects its fees. For instance, while the company has increased its invoice frequency, it has also decreased its reliance on upfront payments for its annual contracts. This means that the increase in its receivable balances has been slower than before.
A common issue with businesses is accounting for unearned revenues. Is unearned revenue a current liability? By recognizing it as a liability, you can balance your books. Unearned revenue is a key metric for investors to watch, as it can provide valuable insight into a company’s potential future revenue. By tracking unearned revenue, you can get a better sense of how a company is performing and where it might be headed in the future.