Is Unearned Revenue a Permanent Account?
Understand the enduring nature of certain accounting liabilities. Learn their classification principles and how they appear on financial reports.
Accounting is the systematic process of recording, summarizing, and reporting financial transactions. This practice provides stakeholders with important information about a company’s financial health. Properly classifying financial accounts is an important aspect of accurate financial reporting, impacting how a business’s financial status and performance are understood.
What Is Unearned Revenue
Unearned revenue, also known as deferred revenue, represents money a company receives for goods or services that have not yet been delivered or performed. This occurs when customers make advance payments for future products or services. Unearned revenue is considered a liability because the company has an obligation to fulfill the service or deliver the product for which it has already been paid. Examples include prepaid subscriptions, advance payments for legal retainers, gift cards, or upfront payments for annual software licenses. Until the company provides the agreed-upon goods or services, the cash received creates a debt to the customer, meaning the payment cannot yet be recognized as earned revenue on its income statement.
Understanding Permanent and Temporary Accounts
In accounting, accounts are categorized as either permanent or temporary, based on how their balances are treated at the end of an accounting period. Permanent accounts, often called “real” accounts, include assets, liabilities, and equity. These accounts are found on the balance sheet and carry their balances forward from one fiscal period to the next, reflecting a cumulative balance.
Temporary accounts, also known as “nominal” accounts, track financial activity within a specific accounting period. These include revenue, expense, and dividend accounts, which are reported on the income statement. At the end of each accounting period, the balances of temporary accounts are closed out to zero and transferred to a permanent account, typically retained earnings, to prepare for the next period. This ensures each new accounting period starts with a fresh slate for these performance-related accounts.
How Unearned Revenue Is Classified
Unearned revenue is classified as a permanent account in financial reporting. This classification stems from its nature as a liability. Liabilities are balance sheet accounts, and all balance sheet accounts are considered permanent because their balances carry forward from one accounting period to the next.
When a company receives an advance payment, it debits its cash account, increasing assets, and credits its unearned revenue account, increasing liabilities. For example, if a software company receives $1,200 for a one-year subscription, the entire $1,200 is initially recorded as unearned revenue. As each month passes and the service is provided, a portion of that unearned revenue, such as $100 per month, is moved from the unearned revenue liability account to an earned revenue account on the income statement. The remaining unearned balance continues to be carried forward on the balance sheet until the service is fully delivered.
Unearned Revenue on Financial Statements
Unearned revenue appears on a company’s financial statements, primarily on the balance sheet. It is listed as a liability, reflecting the company’s obligation to deliver goods or services in the future. Depending on when the goods or services are expected to be delivered, unearned revenue can be classified as either a current liability or a non-current (long-term) liability. If the obligation is expected to be fulfilled within one year, it is a current liability; otherwise, it is a non-current liability.
While unearned revenue does not initially appear on the income statement, it directly impacts it over time. As the company fulfills its obligation by providing the goods or services, the amount is transferred from the unearned revenue liability account on the balance sheet to an earned revenue account on the income statement. This ensures that revenue is recognized only when it is earned, aligning with accrual accounting principles.