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UNEARNED REVENUE: Contract Liabilities, Refunds, Financial Reporting

Unearned revenue refers to payments received before goods or services are delivered. It is recorded as a liability and transferred to revenue only when the performance obligation is satisfied.

1. What Is Unearned Revenue?

Unearned revenue (also called deferred revenue) arises when a customer prepays for goods or services that the company has not yet delivered.

It is a liability because the company owes products, services, or refunds to the customer until delivery occurs.


Common examples:

  • Subscription fees

  • Prepaid insurance or rent

  • Advance ticket sales

  • Annual service contracts


2. Initial Recognition Entry

When cash is received before the service is provided:

  • debit Cash

  • credit Unearned Revenue (Liability)


Example:

On January 1, a business receives $18,000 for a 12-month support contract:

  • debit Cash .................................................. 18,000

  • credit Unearned Revenue .......................... 18,000


3. Revenue Recognition Over Time

As the service is performed or the product is delivered, unearned revenue is reduced and revenue is recognized.


Journal entry (monthly recognition):

  • debit Unearned Revenue

  • credit Service Revenue


Example:

If the company delivers 1/12 of the service each month:

  • debit Unearned Revenue ........................... 1,500

  • credit Service Revenue ............................... 1,500


4. Refunds and Adjustments

If a customer cancels before full delivery, the company must refund the unused portion and adjust the liability.


Entry to refund unused service:

  • debit Unearned Revenue

  • credit Cash (or Payable)

If a partial service has been delivered, only the unused part is refunded.


5. Financial Statement Presentation

  • Balance Sheet: Unearned revenue appears under current liabilities (or non-current if delivery is beyond one year).

  • Income Statement: Revenue is recognized progressively as the service is provided.


6. Contract Liabilities Under ASC 606 / IFRS 15

Unearned revenue is considered a contract liability—an obligation to transfer goods or services in the future.

Companies must:

  • Track contract balances

  • Allocate transaction price to performance obligations

  • Disclose timing of revenue recognition


7. Disclosures and Reporting

Companies must disclose:

  • Significant changes in unearned revenue balances

  • The nature of performance obligations

  • Expected revenue recognition timing (in next 12 months and beyond)


Example disclosure excerpt:

“As of December 31, $4.2 million in unearned revenue relates to advance customer payments for software subscriptions to be delivered over the next 12 months.”

Key take-aways

  • Unearned revenue is a liability until the underlying service or product is delivered.

  • It is recognized as income over time, in proportion to performance.

  • Refunds reduce unearned revenue and may result in cash outflows.

  • Clear contract tracking and proper classification ensure compliance with revenue recognition standards.


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