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Unearned Revenue in Accounting: Definition & Examples

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  • 0:00 Unearned Revenue Explained
  • 0:58 Unearned Revenue Received
  • 1:28 Unearned Revenue Earned
  • 2:17 Canceled Contracts
  • 3:01 Journal Entries
  • 4:20 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Biegala
This lesson will explain the concept of unearned revenue and how it applies in different business settings. It will also explain how and when unearned revenue is recognized and the journal and adjusting entries needed for unearned revenue.

Unearned Revenue Explained

Many businesses receive revenue before they actually provide a good or service. This is called unearned revenue; it is classified as a liability until the good or service is produced. The revenue is transferred from the unearned revenue to the earned revenue account (i.e. sales revenue) once the product or service has been delivered to the customer.

For example, XYZ Company sells insurance, and their customers routinely pre-pay for 12 months of insurance at a time. When XYZ receives the money, it is recorded as unearned revenue because the revenue has not been earned yet. Another example is ABC Pallet Company, which makes wooden pallets for shipping. A customer pays them $25,000 for 1,000 pallets to be delivered in two months. The money received for the pallets is recognized as unearned revenue because the pallets have not been provided to the customer yet.

Unearned Revenue Received

In accrual method accounting, if the company receives money in advance for a product or service, you cannot recognize the money as earned revenue until the good or service is provided, which is why unearned revenue is recorded differently than earned revenue.

In our example of ABC Company's pallets, two months after the customer pays, the pallets are produced and delivered to the customer. To recognize the revenue now that it is earned, you will do an adjusting entry to move the money from unearned revenue to sales revenue.

Unearned Revenue Earned

In cases like ABC Company, you would record the revenue once the pallets are transferred to the customer. At that time, you can transfer the entire $25,000 from unearned revenue to an earned revenue account.

In cases like insurance and subscriptions, the revenue is recognized on a monthly basis. So, using our XYZ Company insurance example, let's say you sell a 12-month policy for $1,200 and receive the money January 1st; the policy takes effect on January 1st. At the end of every month, you will create an adjusting entry to move 1/12 of the money, $100, to sales revenue. By moving the money with an adjusting entry at the end of the month, it is recognized in the month that the revenue was earned. If all of the money is not earned, such as a cancelled contract, the transaction must be handled differently.

Cancelled Contracts

If the contract were cancelled and the good or service was not provided, then the company would need to refund the money the customer paid in advance. For this reason, unearned revenue is considered a liability until the good or service is provided, at which point it can be booked as earned revenue or sales revenue.

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