As you get more sophisticated in your investing, you'll start reading annual corporate reports and quarterly earnings reports. To get a better picture of how a business is doing before you buy its stock, you'll want to look at its income streams, including earned and unearned revenue, which you'll find on the company's balance sheet, explains AccountingTools.com.
Understand Unearned Revenue
Unearned revenue occurs when a company receives payment for services not yet performed, explains the Corporate Finance Institute. Businesses that sell insurance or magazines may have unearned revenue for receiving insurance or subscription payments in advance. Calculating the amount of the unearned revenue occurs by viewing the amount paid in advance.
Adjusting entries must be made in the general journal each month as the company earns the revenue or provides the service. Unearned revenue is a liability that appears on a balance sheet because it places an obligation on a company to perform a service or provide a product.
Read More: Three Phases of the Financial Accounting Process
Confirm Your Cash
As your first step, review the amount of cash the company has received in advance. A copy of the check, a sales invoice or a purchase order received from a customer will show the amount of the service or product purchased. View the sales invoice or purchase order to confirm the number of months associated with the unearned revenue to help you make your calculations.
Debit the Cash Account
Next, you'll debit the cash account for the amount of cash received in advance. For example, if a customer paid $144 in advance for a 12-month magazine subscription, the company must debit cash for $144. This indicates the company has received cash, which increases the company's assets. It also tells you that you have product or services you still need to deliver.
Credit Unearned Revenue
After performing the first two steps, the next entry is a credit in the unearned revenue account. Just like other liabilities, unearned revenue has a normal credit balance, which means a credit to unearned revenue increases the liability. For example, a company that receives $144 in advance for magazine subscriptions must credit unearned revenue for $144. This entry balances out the $144 debit to cash.
Next, draft an adjusting entry to demonstrate the company earning the revenue. Debit the unearned revenue account for the appropriate amount. For example, assume one month has passed since the company received advance payment for the 12 month magazine subscription. Divide $144 by 12 months to determine the cost of a monthly subscription.
In this scenario, debit unearned revenue for $12, since that is the portion of revenue the company has earned. Debiting the unearned revenue account decreases the liability by $12. This amount will be adjusted each month as the year progresses.
Credit Sales Revenue
Finally, record a credit to the sales revenue account for the appropriate amount of money. This entry indicates the company has earned the previously unearned revenue. Crediting a revenue account increases the amount in the company’s revenue account. The credit to sales revenue must equal the debit from the unearned revenue account.
Read More: The Difference Between Retained Earnings & Revenue
Christopher Carter loves writing business, health and sports articles. He enjoys finding ways to communicate important information in a meaningful way to others. Carter earned his Bachelor of Science in accounting from Eastern Illinois University.