Introduction
For a business to be considered successful, it must have regular streams of income (where income is considered payment for rendered services or delivered goods). This essay seeks to analyze a specific kind of revenue, referred to as unearned revenue, with the aim of showing why it is not considered income.
Unearned revenue
Any payment made in advance for services or products to be delivered at a later date is known as unearned revenue. For example, when a telecommunication company sells prepaid airtime through scratch-cards, the money received is considered unearned revenue until the customer has used up his allotted talk-time. Once the service is provided, then the company is allowed to modify its records to regard the revenue as earned.
Another example of unearned revenue is when a person offers a pre-payment for the supply of milk. In this scenario, the entire sum cannot be counted as income until the last bottle of milk is supplied to the customer. Unearned revenue can be registered in any company, provided a payment is made before work is done or a good is delivered. However, the companies that are known to popularly record unearned revenue are newspaper and magazine (subscriptions), telecommunication companies and cable television companies.
Unearned revenue is considered a liability because the paid monies fundamentally represent an obligation to provide services in future. In accounts, income is only recognized once the service or product has been delivered, and this is regardless of whether or not the money for the service has been banked. The process of updating the records to feature unearned revenue is slightly complex, given that the delivery of services sometimes happens incrementally. For instance, if a person buys a US$10 scratch-card and uses it to top up his mobile line, the amount cannot be regarded as income until the customer uses up the entire amount.
However, by the nature of the telecommunication business, usage tends to happen in portions. Therefore, if the customer in our example uses five dollars by the time the records are updated, the unused $5 will be entered under the liabilities list and classified as unearned revenue. The used $5, on the other hand, is listed under income as service revenue. As the consumer continues to use the remaining amount, the records need to be readjusted, with the value of used minutes moved to income and deducted from the liabilities list.
Therefore, the only financial statement that recognizes unearned revenue is the balance-sheet, on which this figure is presented as a liability. It should be noted that unearned money can be claimed back by the customer hence the reason not to have it included in income registers.
Summary and conclusion
This essay had set out to explain what unearned revenue is and to illustrate how and when the revenue is included in financial statements. It has been shown that unearned revenue is any monies that are paid for a service or good to be delivered at a later date. It has also been indicated that unearned revenue is a liability because even though the money is in the company’s accounts, the company will have to use resources later to deliver the promised good or service. Finally, it has been illustrated that unearned revenue can only be included in the balance sheet statement, but under liabilities.