Unearned revenue occurs when a company receives payment for services not yet performed. 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.
Confirm the amount of cash 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.
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.
Write 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.
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.
Record a credit to the sales revenue account for the appropriate amount. 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.
- Learn Financial Accounting: Adjusting Journal Entries
- Accounting Study Guide: Accrual Basis vs. Cash Basis Accounting
- Cliffs Notes: Unearned Revenues
- Internal Revenue Service. "Unearned Income." Accessed Nov. 22, 2019.
- Social Security Administration. "What is 'unearned income'?" Accessed Nov. 22, 2019.
- Internal Revenue Service. "Publication 590-A (2018), Contributions to Individual Retirement Arrangements (IRAs)." Accessed Nov. 22, 2019.
- Internal Revenue Service. "What is Earned Income?" Accessed Nov. 22, 2019.
- 26 U.S.C. 21 - Federal Insurance Contributions Act. "Section 2102: Deduction of tax from wages." Accessed Nov. 22, 2019.
- Internal Revenue Service. "Publication 550 (2018), Investment Income and Expenses." Accessed Nov. 22, 2019.
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.