Unearned Revenue

The single most important of accounting tasks is tracking the revenue of a company. After all, it's the revenue and profit generated by a company, which drives its future performance. The prime indicator of a company or business doing well is its rising quarterly revenue. There is a certain part of revenue, known as the unearned or deferred revenue, which every accounting professional should know about. There are several business transactions that generate an unearned cash pile.

Accounting is tracking cash flow and handling the day-to-day finances of the business, with an eye of sales target. Every single penny that is earned or spent by the business needs to be accounted for. Revenue is the income generated by a company as a result of sale of goods and services.

Definition

It is revenue that's collected from customers by any business, but hasn't been earned yet. In other words, the goods sold or services promised by the company have not yet been provided to the customers, though payments have been collected in advance. This sum of money which has been credited into the accounting books of the company in advance, is known as the unearned revenue.

Until the services and goods are delivered to the end customer, its associated liability cannot be cleared. It is termed to be a liability, because in the event that the terms of the sales contract or service contract are not met, the company may have to refund the money, back to customers. Hence it's essential that the accounting department of a business considers this revenue to be a liability to be repaid till that sum of money is actually earned. It is the exact opposite of accrued revenue, which is revenue that is yet to be received by the company.

There are several instances where unearned revenue may be recorded. One of the prime example is a lease contract, wherein the tenant may have to pay rent in advance. Until the tenant has actually lived through the period of the lease contract, the rent collected is deferred revenue for the owner of the rented apartment.

The price of goods sold online needs to be generally paid in advance, before they are delivered to you. This generates an deferred revenue balance sheet entry for the online business from which you buy the goods. This is especially true of products, which are bought through pre-ordering, where you pay the discounted price weeks in advance before delivery. Most GSM cell phone services collect a pre-paid balance amount from customers, before the customer has used the service. This is paying your cell phone bill in advance, which generates a sizable amount of deferred revenue for the cell phone carrier.

Calculation

A journal entry for deferred revenue is calculated by summing up the total amount of prepayment received by the business before goods and services are actually delivered. Till the service of sales contract is fulfilled, it is treated as a liability. Generally a business will maintain an account for every customer and show the deferred revenue as balance on that account. This revenue will only be debited from the customer account after the terms of service or sold goods are delivered.

Liability associated with unearned revenue needs to be carefully handled by any business and is best left untouched until the service obligations are met or goods are delivered.