This is the case if you don’t expect to either earn the revenue or return the deposit to your customer within the next year. Unearned revenue is very beneficial to many companies and suppliers because of several reasons. Below are three main ways a small business can benefit from unearned income, despite it being a liability. Companies using the accrual method can make use of unearned revenue to help align income with costs and potentially defer income taxes until later periods when revenue has been earned.
So, unearned revenue remains a liability on the books until any risk of having to repay the money is gone. Since the customer may have the option to cancel their order, or the product or service may not get delivered for other reasons, the payment is considered a liability for the company what is unearned revenue receiving it. In any case where the customer doesn’t receive what they ordered, then the company would need to repay the customer. The accounting principle of revenue recognition states that revenue needs to be recognized when it’s earned, not necessarily when payment is collected.
ASC 606 Revenue Recognition Standard
Once the gym delivers the service, it can then recognize the revenue as earned. A deferred revenue schedule is based on the contract between customer and provider. The contract will dictate when payments are due and when deliverables are to be met.
In essence, unearned revenues are generally classified as short-term liabilities because the obligation is usually fulfilled within a period of less than a year. In some cases, the delivery of goods and services may take more than a year, in this case, the unearned revenue will be recognized as a long-term liability. Unearned revenue is a type of liability account in financial reporting because it is an amount a business owes buyers or customers.
Statement of cash flows
Therefore, it commonly falls under the current liability category on a business’s balance sheet. It illustrates that though the company has received cash for its services, the earnings are on credit—a prepayment for future delivery of products or services. The rationale behind this is that despite the fact that the company receives payment from a customer, it still owes delivery of a product or service to a customer. If the company fails to deliver the promised product or service, or the customer cancels the order, the company will owe the money the customer paid. You record prepaid revenue as soon as you receive it in your company’s balance sheet but as a liability. Therefore, you will debit the cash entry and credit unearned revenue under current liabilities.
Every month, once James receives his mystery boxes, Beeker’s will remove $40 from unearned revenue and convert it to revenue instead, as James is now in possession of the goods he purchased. At the end of the six months, all unearned revenue has converted into revenue, since all money received accounts for the six mystery boxes that have been paid for. Therefore, the revenue must initially be recognized as a liability. Note that when the delivery of goods or services is complete, the revenue recognized previously as a liability is recorded as revenue (i.e., the unearned revenue is then earned). In summary, unearned revenue is an asset that is received by the business but that has a contra liability of service to be done or goods to be delivered to have it fully earned.