Unearned Revenue Journal Entry

What is Unearned Revenue?

When a company receives cash or payment while the goods or services have not been delivered or provided for, it is called unearned revenue. Thus, we can define it as the liability which results from the cash received in advance while the goods or services have not been delivered or provided for. The unearned revenue is also called deferred revenue.

This, typically, occurs very often and the accounting treatment, as well as the revenue recognition, should be properly carried out.

When a company receives cash in advance, it creates an obligation to provide goods or services. The advance receipt shall be treated as deferred revenue and only recognize as the real revenue when the goods are delivered or services are rendered.

The unearned revenue is presented in the Balance Sheet under current liabilities and after the revenue is earned this amount will be transferred to Income Statement through adjustment entry which is one part of the accounting cycle.

In this article, we cover the journal entry for unearned revenue transactions as well as the adjustment entry to recognize revenue when it is earned.

So let’s go through together in the later section below.

Unearned Revenue Journal Entry

There are two alternative approaches to record the journal entry of this type of transaction and the subsequent adjustment entries to recognize the revenue when becomes earn. These two approaches are the Liability Method and Income Method. There are two main distinctions between these two methods. These two main distinctions come from different journal entries both on the receipt date and at the revenue recognition date.

READ:  Accounting for Leveraged Buyouts

In addition, when goods or services are delivered and rendered simultaneously over a long period of time, the proportion of revenue shall be recognized as a result of the portion of goods or services delivered or rendered.

Thus, in order to properly account for this, the accountant should maintain a listing or schedule and keep track of completion properly in order to recognize revenue in accordance with the revenue recognition principle.

 Liability Method

Under the liability method, the first entry when a company receives advance payment is directly recorded to the unearned revenue account. Then subsequently is recognized as revenue when the goods or services are delivered or rendered.

When we receive payment both in cash or in-kind in advance for agreed goods or services, the journal entry under this liability method shall be as follow:

AccountDrCr
CashXXX 
Unearned Revenue XXX
(To record unearned revenue for cash receipt in advance)  

After the company has delivered goods or rendered services to its customer, the journal entry to recognize the revenue is as follow:

AccountDrCr
Unearned revenueXXX 
Revenue XXX
(To record adjustment entry to  recognize revenue)  

Income Method

Under the income method, the first journal entry to record the advance receipt is directly recorded to the revenue account. As mentioned above, because the goods or services have not been delivered or rendered, such receipt shall not be recorded as revenue. Therefore, there is another adjusting entry to transfer some unearned portion to the unearned revenue account.

READ:  How to Account for Amortization of Prepaid Expenses?

The first entry to record when a company receives cash under the income method is as follow:

AccountDrCr
CashXXX 
Revenue XXX
(To record as revenue when receiving cash)  

Then, the subsequent adjusting entry to adjust the unearned portion to the unearned revenue account is as follow:

AccountDrCr
RevenueXXX 
Unearned Revenue XXX
(To record adjusting entry of unearned revenue)  

Liability vs Income Method of Unearned Revenue – Key Differences

As mentioned above, there are two main distinctions between the two approaches which are summarized below to easily understand.

Key DifferencesLiability MethodIncome Method
When receiving advance cashRecord as unearned revenueRecord as revenue
Adjusting entryTransfer unearned revenue to revenue when become earnTransfer unearned portion from revenue account to unearned revenue account

At the end of each reporting period, the revenue to be recognized for both methods is the same.

Example

Assume that ABC Co receives cash in advance for the agreed consulting service for 2 months starting from 01 January for a total fee of$10,000. This service will be consumed simultaneously over a two-month period. Thus, the unearned revenue journal entries for both methods are as follows:

Liability Method

The first journal entry when ABC Co receives advance payment on 01 January is as follow:

AccountDrCr
Cash$10,000 
Unearned Revenue $10,000
(To record unearned revenue for cash receipt in advance)  

At the end of 31 January, the service has been simultaneously delivered, 50% of the deferred revenue becomes earned revenue. Thus, the adjusting entry to recognize the revenue earned on 31 January is as follow:

READ:  Sustainability Reporting vs Integrated Reporting (IR)
AccountDrCr
Unearned revenue$5,000 
Revenue $5,000
(To record adjustment entry to  recognize revenue)  

Thus, the remaining balance of $5,000 is still under account unearned revenue.

Income Method

The first entry to record when a company receives cash on 01 January under the income method is as follow:

AccountDrCr
Cash$10,000 
Revenue $10,000
(To record as revenue when receiving cash)  

Then, the subsequent adjusting entry to adjust the unearned portion to deferred revenue account is as follow:

AccountDrCr
Revenue$5,000 
Unearned Revenue $5,000
(To record adjusting entry of unearned revenue)  

Thus, the closing balance of unearned revenue account is $5,000 the same as the liability method.

Conclusion

The unearned revenue journal entry can be recorded in both liability and income methods. These two methods provide the same result of revenue recognition. This is because there is a required adjusting entry to adjust the unearned portion of unearned revenue.

Scroll to Top