By making this journal entry, the company recognizes $6,000 of the prepayment as earned revenue and decreases the unearned revenue account by the same amount. The revenue recognition principle dictates that revenue should be recognized when it is earned, regardless of when payment is received. This principle ensures accurate reflection of a company’s financial performance on its financial statements, allowing stakeholders to make informed decisions.

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How COVID-19 Hits Small Businesses

The sales tax rate varies by state and local
municipalities but can range anywhere from 1.76% to almost 10% of
the gross sales price. Some states do not have sales tax because
they want to encourage consumer spending. Those businesses subject
to sales taxation hold the sales tax in the Sales Tax Payable
account until payment is due to the governing body. Taxes payable refers to a liability created
when a company collects taxes on behalf of employees and customers
or for tax obligations owed by the company, such as sales taxes or
income taxes. A future payment to a government agency is required
for the amount collected. Taxes payable refers to a liability created when a company collects taxes on behalf of employees and customers or for tax obligations owed by the company, such as sales taxes or income taxes.

• Therefore, the seller records it as a liability on the balance sheet before confirming it as earned revenue to the income statement.
• On the balance sheet, the current portion of the
  noncurrent liability is separated from the remaining noncurrent
  liability.
• These computations occur until the entire principal balance is paid in full.
• One limitation is that the money does not belong to the organization.
• The early receipt of cash flow can be used for any number of activities, such as paying interest on debt and purchasing more inventory.
• The following journal entries are built upon the client receiving all three treatments.
• If, after the first year, it is estimated that future repair costs would exceed the remaining unearned revenue, then an additional liability would need to be established.

Unearned revenue, also known as deferred revenue or prepaid revenue, refers to the payments received by a company for goods or services that are yet to be delivered or provided. It is recorded as a liability on the company’s balance sheet because the company owes the delivery of the product or service to the customer. Examples of industries dealing with unearned revenue include Software as a Service (SaaS), subscription-based products, airline tickets, and advance payments for services. As a way to promote sales and develop customer loyalty, many businesses will offer a warranty on their products. A warranty will obligate the company to repair the product if it doesn’t function correctly, or replace it if it cannot be fixed. If the warranty arrangement does not meet definition of a distinct service under IFRS 15, a separate performance obligation is not created.

Unearned Revenue Journal Entry Accounting (Debit, Credit)

When a customer first takes out the loan, most of the scheduled payment is made up of interest, and a very small amount goes to reducing the principal balance. Over time, more of the payment goes toward reducing the principal balance rather than interest. An account payable is usually a less formal arrangement than a promissory note for a current note payable.

With that in mind, let’s look at the process for recording unearned revenue. Unearned income is usually a current liability, but there are situations where it can be a long-term liability. For example, if you own a construction business, you might have a contract to build a restaurant. The total project will take two years, but you require a 50% down payment from your customer.

Resources for Your Growing Business

It is recorded as a liability because the company still has an outstanding obligation to provide these goods or services. Unearned revenue is money received by an individual or company for a service or product that has yet to be provided or delivered. It can be thought of as a “prepayment” for goods or services that a person or company is expected to supply to the purchaser at a later date. As a result of this prepayment, the seller has a liability equal to the revenue earned until the good or service is delivered.