Is Deferred Revenue the Same as Unearned Revenue?
Unpack the accounting principles of deferred and unearned revenue. Gain clarity on their definition and financial reporting implications.
Businesses often receive cash from customers before delivering the promised goods or services. This common financial occurrence requires specific accounting treatment to accurately reflect a company’s financial position. This article clarifies the concepts of deferred revenue and unearned revenue, explaining their definitions, usage, and how they are accounted for in practice.
Defining Deferred Revenue and Unearned Revenue
Deferred revenue represents money a company receives in advance for products or services it has not yet delivered. This amount is initially recorded as a liability on the balance sheet because the company owes something to the customer. For example, if a software company receives a payment for a one-year software subscription, that upfront payment is deferred revenue until the software service is provided over time.
Unearned revenue is cash received by a company for goods or services that have not yet been rendered or delivered. This income is considered “unearned” because the company has not yet completed the work required to recognize it as actual revenue. An example would be an airline selling a ticket for a flight scheduled several months in the future; the ticket price is unearned revenue until the passenger takes the flight.
Interchangeability and Usage
In accounting practice, “deferred revenue” and “unearned revenue” are synonymous terms. They are used interchangeably to describe advance payments received by a business for goods or services not yet provided. Both terms represent a liability, an obligation the company has to its customers.
The existence of two terms for the same concept often stems from historical usage, company preference, or industry-specific jargon. Despite the different names, their accounting treatment and meaning on financial statements remain identical.
Accounting Recognition and Practical Examples
When a business receives an advance payment, the cash account, an asset, increases. Simultaneously, an equal amount is recorded as a liability, either as “deferred revenue” or “unearned revenue,” on the balance sheet. This initial entry reflects the company’s obligation to deliver the goods or services in the future. Until the performance obligation is met, this amount remains a liability, not recognized as earned revenue.
Revenue recognition occurs as the company fulfills its obligation. Over time, or upon completion of the service, a portion of the liability is reduced, and that amount is then recognized as earned revenue on the income statement. This process aligns the recognition of revenue with the delivery of the product or service, adhering to accrual accounting principles.
Consider a homeowner who pays a landscaping company $600 upfront for six months of lawn care services, starting the following month. The landscaping company initially records the $600 as unearned revenue, a liability. At the end of each of the next six months, as one month of service is completed, the company recognizes $100 ($600 / 6 months) as earned revenue, simultaneously reducing the unearned revenue liability by $100.
Similarly, a magazine publisher receiving $120 for a one-year subscription would initially record the full amount as deferred revenue. Each month, as a new issue is delivered, $10 ($120 / 12 months) would be moved from deferred revenue to earned subscription revenue.