What is Unearned Revenue?
458 reads · Last updated: December 5, 2024
Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered. It can be thought of as a "prepayment" for goods or services that a person or company is expected to supply to the purchaser at a later date. As a result of this prepayment, the seller has a liability equal to the revenue earned until the good or service is delivered. This liability is noted under current liabilities, as it is expected to be settled within a year.Unearned revenue is also referred to as deferred revenue and advance payments.
Definition
Unearned revenue is the money received by an individual or company before delivering a service or product. It can be seen as a 'prepayment' for goods or services expected to be provided to the buyer at a later date. Due to this prepayment, the seller's liability equals the appearance of revenue until the goods or services are delivered. This liability is listed as a current liability because it is expected to be settled within a year. Unearned revenue is also known as deferred revenue and advance payments.
Origin
The concept of unearned revenue originates from accounting principles, particularly accrual accounting. As businesses increasingly engage in pre-sales and subscription services, this concept became more prevalent in the mid-20th century. Accounting standards require companies to record prepayments as liabilities until the actual delivery of services or products to ensure the accuracy of financial statements.
Categories and Features
Unearned revenue is primarily divided into two categories: short-term and long-term. Short-term unearned revenue is typically settled within a year, while long-term unearned revenue extends beyond a year. Its features include: 1. Recorded as a liability on the balance sheet; 2. Gradually converted into revenue as services or products are delivered; 3. Provides financial transparency, helping investors understand a company's future revenue potential.
Case Studies
Case 1: Software company Adobe extensively uses unearned revenue in its subscription services. Customers prepay for subscriptions, and Adobe records this as unearned revenue, gradually recognizing it as revenue as services are provided. Case 2: Airlines like American Airlines also record unearned revenue when selling tickets. After passengers book tickets, the airline records the ticket money as unearned revenue, only recognizing it as revenue once the flight is completed.
Common Issues
Investors often misunderstand unearned revenue as actual revenue, leading to misjudgments about a company's financial health. Another common issue is the timing of revenue recognition; companies need to accurately recognize revenue upon the delivery of services or products to avoid financial statement distortion.
