Unearned revenue, or deferred revenue, is income received before delivering goods or services. It is considered a liability until the recipient delivers the promised goods or services. Companies may seek unearned revenue by offering incentives for prepayment, which become assets over time.
Sometimes referred to as deferred revenue, unearned revenue is compensation received before the recipient actually delivers the promised good or service to the buyer. There are many situations where this form of income is generated, including payments on a lease. In general, any unearned income received is considered a liability from an accounting standpoint, until the recipient provides the purchased goods or services to the buyer. At that point, the income is no longer earned, and is counted as earned income.
While many people think of a liability as a debt owed as a result of a purchase, the term can also apply to any funds that are collected before the recipient provides the goods or services ordered by the buyer. This type of unearned or deferred revenue must be accounted for in the company’s billing records. Often the process involves showing unearned revenue in the customer’s account as a beginning balance, then subtracting charges from that balance until all promised products have been delivered to the customer.
There are many situations where some form of prepayment is required to obtain goods or services. A common example has to do with renting or leasing a house or apartment. It is not unusual for landlords to require the tenant to prepay the first and last months of the lease, as this helps reduce the risk the landlord assumes by renting to the tenant. After the first month of residence, a portion of that unearned income is no longer considered a liability, but income. Once the last month of the lease has passed, the remainder of the unearned income is considered earned, and the agreement between the two parties is considered honored.
It’s not unusual for companies that offer products like telecommunications services, property management, or building and construction services to actively seek unearned revenue by offering buyers some form of inventiveness to pay for their contracts up front. For example, a company may offer a percentage discount on each unit of a particular product ordered if the consumer will prepay for all units ordered. The benefit to the business is that the proceeds can be used today to manage the business’s debt, or as a means of raising capital that can be used in an expansion project. As each billing period passes, those prepayments become assets and are no longer listed on the ledgers as liabilities. Ideally, the business has made wise use of those funds and has strengthened its ability to continue to provide goods and services to its clientele.
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