How to Calculate Unearned Revenue

How to Calculate Unearned Revenue
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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

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.

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.