Unearned Revenue

By 
DANIEL LIBERTO
 
 
Reviewed by 
THOMAS BROCK
 
 
Updated Nov 5, 2020
What Is Unearned Revenue?
Unearned revenue is money received by an individual or company for a service
or product that has yet to be provided or delivered. It can be thought of as a
"prepayment" for goods or services that a person or company is expected to
supply to the purchaser at a later date. As a result of this prepayment, the seller
has a liability equal to the revenue earned until the good or service is delivered.
This liability is noted under current liabilities, as it is expected to be settled within
a year.

Unearned revenue is also referred to as deferred revenue and advance

payments.

KEY TAKEAWAYS

 Unearned revenue is money received by an individual or company for a

service or product that has yet to be provided or delivered.
 It is recorded on a company’s balance sheet as a liability because it
represents a debt owed to the customer.
 Once the product or service is delivered, unearned revenue becomes
revenue on the income statement.
 Receiving funds early is beneficial to a company as it increases its cash
flow that can be used for a variety of business functions.
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Unearned Revenue

Understanding Unearned Revenue

Unearned revenue is most common among companies selling subscription-
based products or other services that require prepayments. Classic examples
include rent payments made in advance, prepaid insurance, legal retainers,
airline tickets, prepayment for newspaper subscriptions, and annual prepayment
for the use of software.

Receiving money before a service is fulfilled can be beneficial. The early receipt
of cash flow can be used for any number of activities, such as paying interest on
debt and purchasing more inventory. 

Recording Unearned Revenue

Unearned revenue is recorded on a company’s balance sheet as a liability. It is
treated as a liability because the revenue has still not been earned and
represents products or services owed to a customer. As the prepaid service or
product is gradually delivered over time, it is recognized as revenue on
the income statement. 

If a publishing company accepts $1,200 for a one-year subscription, the amount

is recorded as an increase in cash and an increase in unearned revenue. Both
are balance sheet accounts, so the transaction does not immediately affect the
income statement. If it is a monthly publication, as each periodical is delivered,
the liability or unearned revenue is reduced by $100 ($1,200 divided by 12
months) while revenue is increased by the same amount.

Unearned revenue is usually disclosed as a current liability on a company’s

balance sheet. This changes if advance payments are made for services or
goods due to be provided 12 months or more after the payment date. In such
cases, the unearned revenue will appear as a long-term liability on the balance
sheet.

Unearned Revenue Reporting Requirements

There are several criteria established by the U.S. Securities and Exchange
Commission (SEC) that a public company must meet to recognize revenue. If
these are not met, revenue recognition is deferred.

According to the SEC, there must be collection probability, or the ability to make
a reasonable estimate of an amount for the allowance for doubtful accounts,
completed delivery, or ownership shifted to the buyer, persuasive evidence of an
arrangement, and a determined price.

Example of Unearned Revenue

Morningstar Inc. (MORN) offers a line of products and services for the financial
industry, including financial advisors and asset managers. Many of its products
are sold through subscriptions. Under this arrangement, many subscribers pay
upfront and receive the product over time. This creates a situation in which the
amount is recorded as unearned revenue or, as Morningstar calls it, deferred
revenue.

At the end of the second quarter of 2020, Morningstar had $287 million in
unearned revenue, up from $250 million from the prior-year end. The company
classifies the revenue as a short-term liability, meaning it expects the amount to
be paid over one year for services to be provided over the same period.