What is unearned revenue? Notes on Unearned revenue

Unearned revenue is considered one of the important factors that affect a business's business operations. In this article, let's learn with 1C Vietnam in detail what unearned revenue is , its meaning and important notes related to unearned revenue!

1. What is unearned revenue?

Unearned revenue (also known as unearned revenue) is the amount of money a business receives before providing a product or service to a customer. This can be considered a prepayment by customers for products/services that the business will provide at a specific time in the future. Businesses need to be responsible for the revenue earned until the product/service is delivered.

Unearned revenue is recorded as a short-term liability and is typically paid within 1 year.

2. Typical example of unearned revenue

To simply visualize what unearned revenue is , 1C Vietnam has given a specific example of how to recognize unearned revenue in a business:

Suppose on October 1, 2023, ABC company receives a deposit for a 12-month land lease with a total value of $20,000. To record the unearned revenue account at the end of the accounting period December 31, 2023, we have the following adjusting entry:

On December 31, 2023:

• Debt to Unearned Revenue account (Unearned Rent): $5,000
• Have Rental Revenue account: $5,000

In this example, on October 1, 2023, ABC company received a deposit for a 12-month land lease totaling $20,000. This amount is considered Unearned revenue because it has been received in advance compared to the time the company provides services (land rental). Therefore, to record correctly in accounting books, we debit the Unearned revenue account.

When the end of the accounting period is December 31, 2023 and the company has provided the service for the prescribed time, the advance payment will be transferred to the Rent Revenue account. Therefore, the adjusting entry is used to record the transfer of advance payment to the rental revenue account after the company fully meets the conditions.

3. Meaning of Unearned revenue in business

Unearned revenue is extremely important to business activities including:

• Ensure accuracy and fairness in revenue recognition, accurately reflecting actual business activities.
• Helps users of financial reports have a clear view of the source of money the business has received and the obligations it needs to fulfill in the future.

4. Points to note about unearned revenue

Unearned revenue is recorded as a liability on a company's balance sheet when customers pay in advance for a product or service. This implies that the company is having a responsibility towards the customer in providing the respective product or service.

The customer's prepayment is still considered a debt to the company, as there is still a possibility that the goods/services may not be delivered or that the customer may cancel the order.

In both cases, the company will have to repay the debt to the customer, unless other payment terms are clearly stipulated in the signed contract. Contracts may have different terms, where revenue may not be recognized until all products/services have been delivered. In other words, payments collected from customers remain within the scope of unearned revenue until they are received in full by the customer within the term specified in the contract.

Typically, when a company provides a product/service, unearned revenue is amortized over the income statement until actual revenue is recognized. Improperly timed allocation of unearned revenue, also known as front-loading revenue, is considered an incorrect accounting practice, causing revenue to be "inflated" and actual sales to be overstated. .

Unearned revenue is reported as a current liability on a company's balance sheet because the prepayment period is typically 12 months or less. However, in cases where customers pay in advance for products or services expected to be provided over several years, the portion of the payments related to these products/services should be classified as unearned revenue in long-term debt section on the balance sheet.

Thus, 1C Vietnam has analyzed in detail the correct understanding of what unearned revenue is , its meaning as well as some notes related to unearned revenue. Businesses need to focus on unearned revenue to ensure accuracy and transparency in financial reporting. Don't forget to follow other articles on 1C Vietnam's website to update useful information about corporate governance!