Many organizations adjust entries at the end of each month or period. Accounting for unearned revenue is just one of many types of adjusting entries that businesses complete. Unearned revenue is revenue that is received, but not yet earned. Unearned revenue is categorized as a deferred adjustment.
Understand what a deferred adjustment is. A deferred adjustment is a type of entry completed when cash is received and is recorded as a balance sheet item versus an income statement item. The word “deferred” refers to postponing. A deferred revenue occurs when cash is received for a revenue that the company has not yet earned. This creates an extra journal entry for the company.
Conform to all Generally Accepted Accounting Principles (GAAP). According to GAAP, all expenses and revenues must be recorded on the accounting books during the period in which the activity occurs. This is called the matching principle. Expenses must be recorded when the expense was incurred and revenues must be recorded during the period in which they are earned. Because of this principle, organizations adjust entries to their accounting books. A deferred revenue entry allows companies to abide by this principle.
Receive money. If an organization receives $1,000 on March 1 as a pre-payment from a customer for work that will be completed in April, the company records an initial journal entry using an account called Unearned Revenue. This account is considered a liability account. It is a liability because if an organization received money for work that is not yet done, the company owes this customer completed work or a refund of money. As soon as the money is earned, this liability account’s balance is brought down to zero and the amount is placed into an Earned Revenue account.
Complete the first journal entry. To record the receipt of this cash, the entry is made by debiting $1,000 to the Cash account and crediting $1,000 to Unearned Revenue.
Record the entry when the work is complete. Once the work is performed and the revenue is earned, the company performs another journal entry. This entry consists of debiting Unearned Revenue for $1,000 and crediting Earned Revenue for $1,000.