Why is income received in advance a liability?

Unearned revenue is the money received by a business from a customer in advance of a good or service being delivered. It is the prepayment a business accrues and is recorded as a liability on the balance sheet until the customer is provided a service or receives a product. Technically, you cannot consider deferred revenues as revenue until you earn them—you deliver the products or services prepaid. Deferred revenue is money received in advance for products or services that are going to be performed in the future.

In other words, since $900 of supplies were purchased, but only $200 were left over, then $700 must have been used. Revenue recognition is one reason why the Financial Accounting Standards Board (FASB) issued the Generally Accepted Accounting Principles (GAAP). GAAP accounting metrics include detailed revenue recognition rules tailored to each industry and business type. Emilie is a Certified Accountant and Banker with Master’s in Business and 15 years of experience in finance and accounting from corporates, financial services firms – and fast growing start-ups.

EFRAG draft comment letter on IAS 12 and pillar two income taxes

Common prepaid expenses may include monthly rent or insurance payments that have been paid in advance. Sometimes, businesses receive money relating to the coming month or year which has not been earned yet. Such an income that has not been earned yet but has been received in advance is called Unearned Income.

The value of the current liability is $6,200, the amount of rent received in advance. Media companies like magazine publishers often generate unearned revenue as a result of their business models. 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. Each activity in a publisher’s business strategy can benefit from the resulting cash flow of unearned revenue. The timing of customers’ payments tends to be unpredictable and volatile, so it’s prudent to ignore the timing of cash payments and only recognize revenue when you earn it.

Income Received in Advance FAQs

Often, a business will collect monies in advance of providing goods or services. For example, a magazine publisher may sell a multi-year subscription and collect the full payment at or near the beginning of the subscription period. Such payments received in advance are initially recorded as a debit to Cash and a credit to Unearned Revenue.

The credit to the liability account is made because the company has not yet earned the money and the company has an obligation to deliver the goods or services (or to return the money) to the customer. Accountants will state that the company is deferring the revenue until it is earned. Once the money is earned, the liability will be decreased and a revenue account will be increased. Like small businesses, larger companies can benefit from the cash flow of unearned revenue to pay for daily business operations. Securities and Exchange Commission (SEC) sets additional guidelines that public companies must follow to recognize revenue as earned. An easy way to understand deferred revenue is to think of it as a debt owed to a customer.

SIC-21 — Income Taxes – Recovery of Revalued Non-Depreciable Assets

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. And this is a piece of information that has to be disclosed to complete the image about the financial situation at that moment in time. Deferred revenue is commonplace among subscription-based, recurring revenue businesses such as SaaS companies. When you receive money for a service or product you don’t fulfill at the point of purchase, you cannot count it as real revenue but deferred revenue.

This adjusted trial balance demonstrates the equality of debits and credits after recording adjusting entries. Therefore, correct financial statements can be prepared directly from the adjusted trial balance. It is generally best not to account for a customer advance with an automatically reversing entry, since that will reverse the amount of cash in the following month – and maxine waters the cash paid is still in the cash account. Instead, manually track the amount in the customer advances account each month, and manually shift amounts to revenue as goods are delivered or services provided. This may require the use of a separate step in the month-end closing procedure, to ensure that the status of each customer advance is investigated on a regular basis.