Accrual accounting is an accounting method in which accountants record transactions as they occur. This can lead to recording a transaction without actually recognizing the benefits or gains from it. Unearned sales revenue is a common occurrence under accrual accounting. Companies must record the transaction even though the company cannot recognize the income.
Unearned sales revenue is a liability companies incur during normal operations. This occurs when a customer pays money upfront for goods or services received at a later time. A common example is a magazine subscription. While a customer may pay for the entire subscription upfront, the company cannot recognize the income until it delivers all issues to the customer.
Accountants need to record multiple transactions for unearned sales revenue. First, they debit cash and credit unearned sales revenue. This records the asset received (cash) and the liability that indicates the company owes goods or services to customers. Through normal operations, the company must recognize the income as it complete the obligation. The entry here is a debit to unearned sales revenue and a credit to sales revenue.
Companies must report unearned sales revenue as a liability on their balance sheets. Depending on the length of the agreement, this can be either a short- or long-term liability. Short-term liabilities should go away within the next 12 months. Long-term liabilities for unearned sales revenue may exist in particular industries, such as construction or manufacturing.
Unearned revenue can be a point of contention between a company and its auditors. Companies that have an aggressive income recognition policy may desire to move unearned revenue to normal revenue quickly. The issue, however, is that an aggressive policy may not accurately reflect the business transaction. Companies can inflate their revenue and improve their income statement reporting, which is against standard accounting principles.