What Is Unearned Revenue? A Definition and Examples for Small Businesses
What is unearned revenue? In short, it’s an accounting term that describes prepaid revenue. This is the revenue your business receives from your clients for future work. Before the work is produced, this revenue is marked as a liability on your ledger. This is because it is money (goods or services) that your business owes an outside entity. After you produce the goods or services that were prepaid, the liability entry is adjusted.
Examples of Unearned Revenue for Small Businesses
There are as many examples of unearned revenue as there are unique small businesses. Here are a few of the most common examples.
A service contract that was paid for in advance is one of the most common types of unearned revenue. This could be a monthly subscription for services like on-demand home or business repairs such as HVAC, IT, or cleaning. This subscription is either paid for monthly or you might offer your clients a discount for paying a year’s worth of services in advance.
Lawyers regularly receive unearned revenue as they secure a retainer from their clients which they will bill their hours against while representing them. For accounting purposes for legal retainers, you will mark the retainer as a liability and adjust it when the retainer has been exhausted or if any outstanding balance is refunded.
Advance Rent Payments
If your tenant pays their rent in advance it will be considered unearned revenue. While this is a rare occurrence with residential tenants, it is more common if you rent out office space and require your clients to prepay for six months or a year. This also applies if you own a temporary rental property like an event venue or vacation home. The deposit and rental fee your client pays is unearned revenue until the event or stay has been completed.
If you own an insurance company, then you likely deal with unearned revenue. While some of your clients pay monthly premiums, you may offer discounts for your customers if they prepay their insurance premium either in fewer payments, or in full at the beginning of the policy. This unearned revenue will be marked as a liability on your ledger and adjusted when the policy has ended or until the prepaid amount has been fulfilled in cases of fewer payments but not completely paid in full.
How to Make a Journal Entry for Unearned Revenue
Unearned revenue is marked in your accounting ledger as a debit to your cash account and a credit to your unearned revenue liability account. This notes that your business received cash from your client but that it has not been earned or performed yet so remains a liability. Once the goods or services have been provided for the prepaid amount, you will debit your unearned revenue liability account and credit your revenue account.
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