Unearned revenue is typically considered a current liability on a business’s balance sheet because, at that point, the business is in debt to the customer . Receiving money before a service is fulfilled can be beneficial. However, with quarterly or annual contracts, customers often pay upfront, meaning that the company has received cash before providing the service—leading to unearned revenue on the company’s books. In accrual accounting, it is important to organize income properly, especially when it comes to prepaid services. Unearned revenue is a liability and is treated in a very unique way. What happens when a business receives payments from customers before a service has been provided?

Premature recognition of income is considered “creative” or “aggressive” accounting which is a move subject to penalty by the Securities and Exchange Commission . GoCardless is authorised by the Financial Conduct Authority under the Payment Services Regulations 2017, registration number , for the provision of payment services. The GoCardless content team comprises a group of subject-matter experts in multiple fields from is unearned revenue a liability across GoCardless. The authors and reviewers work in the sales, marketing, legal, and finance departments. All have in-depth knowledge and experience in various aspects of payment scheme technology and the operating rules applicable to each. ScaleFactor is on a mission to remove the barriers to financial clarity that every business owner faces. We’ve compiled a list of terms we think business owners should know.

Definition and Example of Unearned Revenue

It’s a buyer prepaying for something that will be supplied at some point in the future. FreshBooks has online accounting software for small businesses that makes it easy to generate balance sheets and view your unearned revenue. It would go in the “liabilities” category, as it is money owing. The business has not yet performed the service or sent the products paid for. After two months, she attends five personal training session. This means she’s done 25 percent of her 20 pre-paid sessions.

The company classifies the revenue as a short-term liability, meaning it expects the amount to be paid over one year for services to be provided over the same period. Like small businesses, larger companies can benefit from the cash flow of unearned revenue to pay for daily business operations. Securities and Exchange Commission sets additional guidelines that public companies must follow to recognize revenue as earned. Let’s say you have a converted customer who makes a booking for your annual SaaS subscription services in January valued at $12,000 ($1000 per month). From aSaaS accountingperspective, you will not earn that revenue until you deliver what you sold to the customer. It means that the $12,000 deferred revenue turns into revenue gradually with each month as the subscription progresses. Thus, each month you recognize earning $1000 from the account.

What is the difference between deferred revenue and unearned revenue?

Technically, you cannot consider deferred revenues as revenue until you earn them—you deliver the products or services prepaid. Therefore, you cannot report these revenues on the income statement. Instead, you will report them on your balance sheet as a liability. You can only recognize unearned revenue in financial accounting after delivering a service or product and receiving payment. But since you accept payment in advance, you must defer its recognition until you meet the above criteria. Read on to learn about unearned revenue, handling these transactions in business accounting, and how ProfitWell Recognized from ProfitWell help simplify the process.

In accrual accounting, assets need equal liabilities, in the same period. At the start of February, you need to record the first month of service as income. Think of it as a customer paying for monthly service, but you already have the money. This decreases your unearned revenue liability because you performed the service. A deferred revenue schedule is based on the contract between customer and provider. The contract will dictate when payments are due and when deliverables are to be met.

Where does unearned (prepaid) revenue go on a balance sheet?

If all of the money is not earned, such as a cancelled contract, the transaction must be handled differently. There are no contra-accounts involved in the standard accounting journal entries for deferred unearned revenue prepayments. Unearned revenue is recorded whenever a customer pays for a service or product before they receive it. Your business receives the money upfront, and then does the work to earn it at a later date. It’s categorized as a current liability on a business’s balance sheet, a common financial statement in accounting.