The accounting equation identifies three major classifications of business transactions. These items include assets, liabilities and owner’s equity. Unearned revenue is a liability, as a company receives funds for goods not yet delivered or services not yet performed. Proper accounting is necessary to ensure the company does not mislead stakeholders in this information.
Unearned revenue is a liability because a company owes goods or services to another party. Companies often enter contracts that result in upfront payments. Accounting principles, however, restrict the company from actually recognizing the income until completing the contract. Essentially, income recognition has an inexplicable link to task completion. Revenues will remain unearned until all tasks reach completion based on agreements between two parties.
Basic journal entries are necessary to record unearned revenue into the general ledger. The first entry debits cash for money received and credits unearned revenue, a liability account. This recognizes the company’s responsibility to fulfill its obligations to consumers. The second entry will recognize revenue as the company works toward task completion. Accountants debit unearned revenue and credit revenue for this entry.
Financial Statement Reporting
The balance sheet contains all liabilities a company owes to outside parties. Unearned revenue is typically a current liability. Under this designation, the company does not expect the liability to last longer than 12 months. A disclosure may be necessary to inform stakeholders on the nature of this account. In many cases, unearned revenue is not a common liability that lasts for several periods, giving rise to the disclosure requirement.
Aggressive revenue recognition policies attempt to avoid the use of an unearned revenue account. Companies look to recognize revenue immediately rather than deferring it to a later period. Audits may determine a company’s revenue recognition policy inadequate or does not follow generally accepted accounting principles. This can result in restatements or adjustments to a company’s books to correct any reporting errors.