What Is Unearned Revenue?
Let me explain unearned revenue directly: it's the money a company receives before it has actually provided the goods or services. You can think of it as payment for something that's still owed to the customer. For example, when you pay your Netflix subscription monthly, that's unearned revenue for them until they deliver the streaming service. You'll see this in things like magazine subscriptions, rent paid in advance, and prepaid insurance policies. On the balance sheet, companies list it as a current liability since it's typically settled within a year. Once they deliver, it shifts to earned revenue on the income statement.
Key Takeaways
- Unearned revenue is advance money for undelivered items or services.
- It's recorded as a current liability on the balance sheet and becomes earned revenue on the income statement after delivery.
- Examples include subscription services, rents, and prepaid insurance.
Understanding Unearned Revenue
You often encounter unearned revenue in businesses that sell subscriptions or require prepayments. Think rent paid upfront, prepaid insurance, legal retainers, airline tickets, newspaper subscriptions, or annual software fees. Getting this money early helps with cash flow—you can use it to pay debts, buy inventory, or invest in growth. It's straightforward: the cash comes in before the work is done, and that can keep operations running smoothly.
Recording Unearned Revenue
When recording unearned revenue, treat it as a liability on the balance sheet because it's essentially a debt to the customer for undelivered products or services. As you deliver over time, recognize it as revenue on the income statement. Take this example: if a publishing company gets $1,200 for a yearly subscription, it increases cash and unearned revenue on the balance sheet—no immediate income statement impact. For a monthly publication, each delivery reduces the liability by $100 and adds $100 to revenue. Usually, it's a current liability, but if delivery is over 12 months away, it becomes a long-term liability.
Unearned Revenue Reporting Requirements
Public companies must meet SEC criteria to recognize revenue; otherwise, it's deferred. You need probable collection, a reasonable estimate for doubtful accounts, completed delivery or ownership transfer, evidence of the arrangement, and a fixed price. These rules ensure accurate reporting—don't recognize it until everything checks out.
Example of Unearned Revenue
Consider Morningstar Inc., which sells financial products and services, many through subscriptions where customers pay upfront. This gets recorded as unearned or deferred revenue. By the end of Q2 2020, they had $287 million in unearned revenue, up from $250 million, classified as a short-term liability since services would be provided within a year. Changes in this balance can signal future revenue trends, but watch for business shifts like fewer annual upfront payments, which might slow growth in the balance.
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