Let's say you have a converted customer who makes a booking for your annual SaaS subscription services in January valued at $12,000 ($1000 per month). From a SaaS accounting perspective, you will not earn that revenue until you deliver what you sold to the customer. It means that the $12,000 deferred revenue turns into revenue gradually with each month as the subscription progresses. Deferred revenue (aka unearned revenue) gets recorded on a company’s balance sheet as a liability. On July 1, Magazine Inc would record $0 in revenue on the income statement, since none of the money has been earned yet. Cash on the balance sheet would increase by $60, and a liability called unearned revenue would be created for $60 to offset it.

On July 1, Magazine Inc received a $60 payment for a one-year subscription from a new customer. The balance sheet, also known as the “Statement of Financial Position,” presents a snapshot of a business's assets, liabilities, and equity. It provides a true picture of company financial data used in decision-making.

Unearned Revenue

This amount of $100,000 paid to the contractor is an example of unearned revenue because the contractor is yet to complete the job. Hence, the total amount received for the project would be recorded as unearned revenue because the project is yet to be completed. This journal entry reflects the fact that the business has fulfilled its obligation to the customer, and the revenue can now be recognized as earned. It also reduces the unearned revenue liability by the same amount, as the business no longer has an outstanding obligation related to this revenue. Per accrual accounting reporting standards, revenue must be recognized in the period in which it has been “earned”, rather than when the cash payment was received.

• You record it under short-term liabilities (or long-term liabilities where applicable).
• For example, the publisher needs the cash flow to produce content through its various teams, market the content compelling to reach its audience, and print and distribute issues upon publication.
• A credit memo states the customer no longer owes towards the contract.
• That $1,000 is considered income and goes on the income statement for January.
• Finvisor has ASC606 experts that can ensure you are recognizing revenue accurately and in accordance with all GAAP requirements.

Under the accrual basis of accounting, revenue should only be recognized when it is earned. Likewise, when the company receives the early cash payment for the rental service, it should record the cash received as unearned rent revenue in the journal entry. Deferred revenue refers to money you receive in advance for products you will supply or services you will perform in the future. For example, annual subscription payments you receive at the beginning of the year or rent payments you receive in advance. This deferred revenue definition implies a lag between purchase and delivery.

Why is Unearned Revenue a Liability?

In this case, the company ABC needs to record the $2,000 of cash received as an unearned rent revenue in the journal entry on December 29, 2020. Perform a monthly check of your balance sheet and the income statement. If you have booked revenue too early you will need to start from https://simple-accounting.org/ scratch and recalculate your earnings for all accounts. Improper revenue recognition will result in an overstated revenue account balance, and understated deferred income account balance. However, there might be an element of unrealized profit included in the liabilities.

A business then would perform the service monthly and recognize a certain amount of revenue each month. Examples of unearned revenue are prepaid rent, prepaid insurance, annual subscriptions for a software license. Deferred revenue is expected among SaaS companies because they offer subscription-based products and services requiring pre-payments.

What To Do If You Prematurely Recognized Unearned Revenue?

The first journal entry reflects that the business has received the cash it has earned on credit. Businesses can profit greatly from unearned revenue as customers pay in advance to receive their products or services. The cash flow received from unearned, or deferred, payments can be invested right back into the business, perhaps through purchasing more inventory or paying off debt. Unearned revenue is the income a company or an individual receives in advance for a good or service.

The initial entry for this liability is a debit to cash, and a credit to the unearned revenue account. 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). So $100 will come out of the revenue account and you will credit your expense account $100. It is important to perform these adjusting entries to recognize deferred revenue according to the contract set in place.

Why companies record unearned revenue

Also, the seller tends to have the cash to perform the required services that have been paid for. A prepayment adjusting entry would be noted on the books for January. You also need to enter a credit of $4800 to the deferred revenue account. The subscription for monthly accounting service is considered a short-term liability on the balance sheet. Unearned revenue is usually disclosed as a current liability on a company’s balance sheet.

• In this case, the company ABC needs to record the $2,000 of cash received as an unearned rent revenue in the journal entry on December 29, 2020.
• But it is highly recommended for businesses working toward becoming a public company or attracting serious investors.
• On July 1, Magazine Inc received a $60 payment for a one-year subscription from a new customer.
• According to the accounting reporting principles, unearned revenue must be recorded as a liability.
• Instead, any rent payments received are recorded as income at once.
• Hence, unearned revenue is not initially recorded as revenue, but as a current liability until the revenue is earned.
• As a result, unearned revenue is a liability for any company that has already received payment without delivering the product.

At the start of February, you need to record the first month of service as income. Think of it as a customer paying for monthly service, but you already have the money. This decreases your unearned https://simple-accounting.org/is-unearned-revenue-a-liability/ revenue liability because you performed the service. Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered.

Due to the revenue recognition process, cash flow and income are not inherently linked. You can have deferred revenue on the cash flow statement without income, you can also have income without inflows of cash. With the provider and customer agreeing to delivery of a services or goods, at a specified time, for a specified price. These contracts will always cross over into another accounting period, often spanning a year or longer. Contract terms, fees, and requirements must be outlined and adhered to.