Unearned revenue is the sum of money received by the business from a customer for a service or a good that is yet to be provided to the customer. It is a “prepayment” for goods and services. When a business receives revenue before they provide a good or a service to the client unearned revenue arises ( Weygandt et al ., 2015). It is classified as a current liability in accounting because the money received by the business from the customer can still be refunded to the customer for the reason that it is not yet recognized as revenue. The business has a liability equal to the amount paid by the customer until the business delivers the good/service to the customer. Also, the unearned revenue is commonly classified as a current liability on the balance sheet because when a business receives revenue, the balance in the unearned revenue account reduces and the balance in the revenue account increases.
Business activities examples that result in unearned revenue include a landlord collecting rent in advance, prepaid insurance, paying service contractors in advance. Another example would be a law firm XYZ informing a customer that a cash deposit of $4,000 is required before they can begin working on the customer’s case. If for instance, the customer paid the amount in November the law firm will debit the cash account for $4,000 and credit the unearned revenue account for $4,000. Recognizing unearned revenues affects the financial statements. When a business receives payment in advance, the unearned revenue is not reflected at the top of the operating section. The unearned revenue is hence recorded as a cash inflow in the operating section. Cash generated from operating activities is adjusted by the amount of the unearned revenue. After providing the service, the operating cash flow is adjusted downwards by the earned amount.
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Reference
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & Managerial Accounting . John Wiley & Sons.
