Revenue is only included in the income statement when it has been earned by a business. If the business receives payment or invoices in advance then the revenue is classified as unearned and carried as a liability on the balance sheet until the business has carried out the services or supplied the product.
For example, suppose a business provides equipment maintenance services and invoices customers 6,000 annually in advance. When the invoice is issued, no maintenance cover has been provided and therefore the revenue of 6,000 is unearned and a journal entry is required.
The unearned revenue journal entry will be as follows.
Unearned Revenue Journal Entry
|Unearned revenue account||6,000|
Unearned Revenue Journal Entry Bookkeeping Explained
The debit to accounts receivable reflects the amount invoiced and due from the customer under the terms of the contract.
At the date of invoicing the business has not supplied any services to the customer and the revenue is therefore unearned. The credit to the unearned revenue account is a balance sheet liability indicating that the business has an obligation to provide the customer with services.
Accounting Equation for Unearned Revenue Journal Entry
The accounting equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the total equity of the business. This is true at any time and applies to each transaction.
For this transaction the accounting equation is shown in the following table.
In this case one asset (accounts receivable) increases representing money owed by the customer, this increase is balanced by the increase in liabilities (unearned revenue account).
Unearned revenue is classified as a liability (credit) as the service still needs to be provided to the customer.
Unearned Revenue Recognition
Unearned revenue recognition will happen as soon as the service is provided.
In the above example, the maintenance contract costs 6,000 for one year, assuming the business produces monthly management accounts, each month 500 will be become recognized revenue and credited to the services revenue account in the income statement with the following journal entry
|Unearned revenue account||500|
|Service revenue account||500|
At the end of 12 months all the unearned service revenue (unearned) will have been taken to the service revenue account (earned).
A similar situation occurs if cash is received from a customer in advance of the services being provided. This is more fully explained in our revenue received in advance journal entry example.
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About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.