Is Unearned Revenue A Liability Top 3 Reasons

Is Unearned Revenue a Liability?

In this article, we provide the top 3 reasons why unearned revenueUnearned RevenueUnearned revenue is the advance payment received by the firm for goods or services that have yet to be delivered. In other words, it comprises the amount received for the goods delivery that will take place at a future date.read more is classified as a liability –

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Reason #1 – Payment is Received in Advance

When the company receives the money in advance for the product or the services, but the goods have not been delivered, or the services have not been rendered to the party providing the advance. As per the accrual accountingAccrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more, a person cannot recognize the money and cannot treat the money received as the earned revenue until and unless the goods have been delivered or the services have been rendered to the party, as the case may be. It is because the unearned revenue of any company is recorded differently than the earned revenue. The advance received becomes the liability to the company till the goods have been delivered or the services have been rendered to the party and will be shown on the liability side of the balance sheet.

Example

Reason #2 – Can Cancel the Contract any Time

The person receives the money from one party for which the goods have been delivered, or the services have been rendered to the party. Now, in case the party cancels the contract, then, in that case, the company would be liable to refund the amount of money received from the customer in advance. So, considering this reason, the unearned revenue for which the goods have been delivered or the services have been rendered to the party is considered the liability and will be shown as the liability in the balance sheet of the company until the goods are delivered, or the services are provided, after which the company can book the amount received as the earned or sales revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity’s income statement/profit & loss account.read more.

Company X ltd produces and supplies sports equipment in one area. Mr. Y provided the advance to the company X ltd of $ 50,000 for the supply of certain sports equipment after one month. After 15 days, Mr. Y asks the company to cancel the order. The company, after receiving the cancellation request from the customer, canceled the order and refunded the amount back to Y. So, in this case, Company X cannot recognize the amount received as advance as its revenue and has to show the same as its liability because when the order gets canceled, then it is liable to refund back the advance amount to the customer.

Reason #3 – Services not Provided/Goods not Supplied

The company should recognize the revenue earned once the goods have been supplied or the services have been rendered to the customers if the risk and rewards related to goods or services have not been transferred to the customer from the supplier. Until then, the company should not recognize the revenue even if it has received the amount against it.

Company B ltd. Got the order to supply office equipment to Company C ltd after two months, for which the advance payment was received in full. Since the goods have not been provided to Company C, risks and rewards related to the goods have not been transferred. Now the company will treat the advance amount received as its liability until the risk and rewards are transferred, after which the entire advance will be transferred from unearned revenue to the earned revenue accountRevenue To The Earned Revenue AccountRevenue accounts are those that report the business’s income and thus have credit balances. Revenue from sales, revenue from rental income, revenue from interest income, are it’s common examples.read more.

Conclusion

Unearned revenue is the money received by the company or an individual for the service or product that has to be rendered or delivered yet. Since the money is received in advance by the company, the same is to be recorded on the balance sheet of the company as the liability because the advance received represents the debt owed by the company to the customer who has given the advance but has not received the services or goods for which the amount is paid.

Once the company delivers the product or provides the service to the company for which the amount is received in advance, then the unearned revenue will become the revenue and will be considered as the income on the income statement Income Statement The income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read moreof the company and will no longer be a liability.