What type of account is unearned rent revenue?

Payment received, but Good or Service still hasn't been delivered

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Accounting for Unearned Revenue
Example of Unearned Revenue
Related Readings
What Is Unearned Revenue?
How to Record Unearned Revenue
Go Digital with Accounting Software
Unearned Revenue FAQ
Key Takeaways
Related Articles

Unearned revenue, sometimes referred to as deferred revenue, is payment received by a company from a customer for products or services that will be delivered at some point in the future. The term is used in accrual accounting, in which revenue is recognized only when the payment has been received by a company AND the products or services have not yet been delivered to the customer.

Some examples of unearned revenue include advance rent payments, annual subscriptions for a software license, and prepaid insurance. The recognition of deferred revenue is quite common for insurance companies and software as a service (SaaS) companies.

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Accounting for Unearned Revenue

Accounting reporting principles state that unearned revenue is a liability for a company that has received payment (thus creating a liability) but which has not yet completed work or delivered goods. The rationale behind this is that despite the company receiving payment from a customer, it still owes the delivery of a product or service. If the company fails to deliver the promised product or service or a customer cancels the order, the company will owe the money paid by the customer.

Therefore, the revenue must initially be recognized as a liability. Note that when the delivery of goods or services is complete, the revenue recognized previously as a liability is recorded as revenue (i.e., the unearned revenue is then earned).

Generally, unearned revenues are classified as short-term liabilities because the obligation is typically fulfilled within a period of less than a year. However, in some cases, when the delivery of the goods or services may take more than a year, the respective unearned revenue may be recognized as a long-term liability.

Example of Unearned Revenue

Fred is an avid user of Amazon.com’s services. Recently, he discovered Amazon Prime services. Fred wants to enjoy the benefits of the service, such as free two-day shipping and access to unlimited music streaming and buys the annual subscription for $79.

For Amazon, Fred’s payment ($79) is unearned revenue since the company receives the full payment in advance while none of the services have been provided to Fred yet. Initially, the full amount will be recognized as unearned revenue on Amazon’s balance sheet.

However, at the end of the first month, the monthly portion of the total amount ($79/12=$6.58) will be deducted from the unearned revenue figure and recorded as the revenue. A similar procedure will be repeated each subsequent month until the end of the 12th month when the last portion of the payment will be recognized as revenue.

Thank you for reading CFI’s guide to Unearned Revenue. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources listed below:

You’re probably thinking: unearned revenue has to be a revenue account, right?

The word revenue is in it!

Well, although that’s a fair assumption, unearned revenue is in fact considered a current liability. It’s recorded under a business’ balance sheet, along with other types of liabilities, assets, and owner’s equity.

But what makes unearned revenue a liability? How is this liability account recorded?

That’s exactly what we will be answering in this guide, along with everything else you need to know about unearned revenue in accounting.

Read on to learn about:

What Is Unearned Revenue?

Plenty of businesses offer services that their clients have to pay in advance for, such as rent, prepaid insurance, newspaper subscriptions, annual gym memberships, and so on.

In accounting, these prepayments are recorded as unearned revenue.

By definition, unearned revenue (or deferred revenue) is cash received from a customer for a service that hasn’t been provided yet. So, this profit is labeled as “unearned” since it is still an obligation for the business.

Now, keep in mind that the recording of unearned revenue is only valid for businesses that use the accrual basis of accounting.

In accrual accounting, businesses must comply with several accounting principles that dictate when bookkeeping is done.

One of these principles relates to revenue recognition and states that revenue should be recorded when it is earned, rather than when cash is received.

With cash basis (the alternative accounting method to accrual) on the other hand, unearned revenue doesn’t exist as an account because revenue is only recorded once cash flows in.

As we previously mentioned, unearned revenue is an obligation that the business is yet to settle.

If a prepaid good or service becomes undeliverable (or even if the client cancels their order) the business must pay the client back as it is liable for the delivery or completion of that good or service.

That’s why unearned revenue is considered a current liability account under the balance sheet.

Deferred revenue is reported as a current liability and not a long-term one as prepaid goods and services are typically delivered (or cancelled) within one fiscal year.

If that’s not the case and the service has a delivery date that exceeds 12 months, then unearned revenue is listed under long-term liabilities.

Other liabilities in accounting include accounts payable, bank account overdrafts, accrued expenses, income tax payable, capital leases, and so on.

To learn more about the different accounts in financial accounting and how to record them, head over to our chart of accounts guide.

How to Record Unearned Revenue

To record unearned revenue, you need to make two journal entries: one to recognize the prepayment, and another to convert it into service revenue as it is earned.

Prepayments are recorded as a credit to Unearned Revenue and a debit to the Cash account.

Then, once the order or service is completed, an adjusting entry is made which debits Unearned Revenue and credits Service Revenue (or Sales Revenue).

To understand what that means, let’s take a look at an example:

A customer pays $200 for an annual gym membership from company XYZ. At this point in time, the revenue is recognized as a liability through the following journal entry:

After the membership period ends, unearned revenue is converted into service revenue with this adjusting entry:

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Unearned Revenue FAQ

#1. How Do I Calculate Unearned Revenue?

Unearned revenue is pretty straightforward to calculate.

It is the sum of all customer deposits and/or advance payments for products and services. It increases with every additional payment clients make and decreases as time passes and that revenue becomes earned.

#2. What’s the Difference Between Unearned Revenue and Deferred Expenses?

Deferred expenses, or prepaid expenses, are payments that you make in advance, for services such as insurance coverage - you pay in advance for a cost you have yet to incur.

Conversely, unearned revenue refers to cash received from a customer that hasn’t been earned yet.