Unearned revenue is a current liability account which represents cash received from customers against which no goods have been delivered or services have been performed.
Since revenue is recognized on accrual basis, receipt of cash is not the point at which a company can recognize revenue. When cash is received a company increases its cash and records a liability representing the obligation to provide goods or perform services against the cash received. Subsequently, when the goods have been delivered or services have been performed the company records revenue and settles the liability.
Unearned revenue normally appears in books of newspaper publishers, entertainment companies, telecommunication operators etc. because the nature of their business is such that cash is received before services are provided.
Voice is a VoIP company which provides innovative voice calling solutions. Assume that during the month of January 2012 its users purchased talk time worth of $10 million. Voice would record this purchase as follows:
|Unearned Revenue||10 million|
The purchase of talk time is just an advance payment for services which Voice has to provide. Since there is a cash inflow and an increase in cash there is an offsetting increase in liabilities.
The users consumed $8 million of the talk time purchased in July by the end of February. Since the company has now provided the services it is entitled to record related revenue as follows:
|Unearned Revenue||8 million|
$2 million worth of revenue is still unearned at the end of February (assuming no additional purchase of credit). If the users had purchased $9 worth of talk time the balance in the unearned revenue account at the end of February would have been $11 million ($2 million opening unearned revenue plus $9 additional talk time purchased).
Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork