Does Unearned Revenue Go on the Income Statement?

Companies often receive payments from customers before delivering the associated goods or services. This creates a common accounting situation known as unearned revenue. This article clarifies the accounting treatment of unearned revenue and its presentation on financial statements.

What is Unearned Revenue

Unearned revenue represents cash a business receives from a customer for goods or services that have not yet been provided. It is an advance payment received for a future obligation. For example, if a customer pays for a year-long subscription upfront, the company has received cash but has not yet delivered most of the service.

Because the company still owes the customer the goods or services, unearned revenue is considered a liability on the balance sheet, not immediate revenue. When a company initially receives this cash, it increases its cash balance (an asset) and simultaneously increases its unearned revenue account (a liability).

How Unearned Revenue Becomes Earned Revenue

The transformation of unearned revenue into earned revenue occurs when the company fulfills its obligation to the customer. This means the goods must be delivered, or the services must be performed. For instance, in the case of a prepaid annual subscription, the revenue is earned incrementally as each month of the subscription passes and the service is provided.

The accounting process reflects this transition. As the company delivers a portion of the goods or services, the unearned revenue liability is reduced by that amount. Simultaneously, an equivalent amount of revenue is recognized on the company’s books. This adjustment reflects that the company has satisfied a part of its obligation and earned that portion of the payment.

Impact on the Balance Sheet and Income Statement

Unearned revenue does not appear on the income statement. Instead, when cash is first received for goods or services not yet delivered, it is recorded as a liability on the balance sheet. This liability signifies the company’s obligation to provide future goods or services. This initial entry increases both cash (an asset) and unearned revenue (a liability).

Only after the goods or services are delivered and the revenue is earned does it appear as revenue on the income statement. The journey of this money begins as a liability on the balance sheet, reflecting a future obligation. As the company fulfills its performance obligations, the unearned revenue liability on the balance sheet decreases, and the corresponding amount is moved to the revenue section of the income statement. This aligns with accrual accounting principles, which dictate that revenue should be recognized when it is earned, regardless of when the cash is received. The income statement provides a picture of the revenue a company has earned through its operations during a specific period, not simply the cash it has collected.

Illustrative Scenarios

When a customer purchases a one-year software subscription for $120 upfront, the entire $120 is initially recorded as unearned revenue on the company’s balance sheet. Each month, as the customer uses the software, $10 ($120/12 months) is recognized as earned revenue on the income statement, and the unearned revenue liability decreases by $10.

Another example involves gift cards. When a retail store sells a $50 gift card, the $50 received is recorded as unearned revenue because the store has an obligation to provide goods or services in the future. Only when the customer redeems the gift card to purchase items does that $50 transfer from unearned revenue to earned sales revenue on the income statement. Similarly, a lawyer receiving a $5,000 retainer for future legal services initially records it as unearned revenue. As the lawyer performs work and bills against the retainer, the corresponding portion of the $5,000 is recognized as earned revenue.