Accrued vs Unearned Revenue: A Deep Dive into the Basics of Accounting

Accounting can be a tricky field, filled with complex terms and concepts, but understanding key revenue-related concepts like “accrued revenue” and “unearned revenue” is essential for any accounting student. These two terms are fundamental for recognizing when a business should report revenue, and how that revenue should be accounted for on financial statements.

This tutorial will explore what accrued revenue and unearned revenue are, how they differ, and how to record these types of revenue in the accounting books. Through clear examples, journal entries, and detailed explanations, you’ll gain a solid understanding of these essential concepts.

What is Accrued Revenue?

Accrued revenue refers to income that has been earned by a company but has not yet been received in cash or recorded. It occurs when a company provides goods or services to a customer, but payment has not yet been received. The company has a right to the payment, and the revenue is recognized as earned, even though the cash has not yet been received.

In accounting, revenue is typically recorded when it is earned, not necessarily when payment is received. This follows the accrual basis of accounting, which is a core principle in accounting. Accrued revenue is recognized in a company’s financial records at the point when the service or product is delivered, even if cash payment has yet to be made.

Example of Accrued Revenue

Imagine a consulting company that provides a service in December, but the client doesn’t pay for the service until January. The company has earned the revenue in December when the service was provided, even though cash will not be received until the next month.

Journal Entries for Accrued Revenue

In the case of accrued revenue, the company records the earned revenue and the corresponding receivable. Here’s how it would look:

In this example, the company has earned $1,000 in service revenue, which is recognized in December. However, since the cash hasn’t been received yet, the amount is recorded as an Accounts Receivable, which represents an amount owed by the customer.

When the payment is finally received in January, the company will record the cash receipt and reduce the Accounts Receivable balance:

In this journal entry, cash is received, and the outstanding receivable is cleared. Notice that the revenue has already been recognized in December when the service was provided.

What is Unearned Revenue?

Unearned revenue, on the other hand, refers to money received by a business in advance of providing goods or services. This revenue is considered a liability, as the company has an obligation to deliver the goods or services at a future date. Unearned revenue is typically recorded in situations where customers pay before receiving the product or service.

For example, consider a subscription-based service like a magazine. If a customer pays for a one-year subscription in advance, the company has received cash but has not yet delivered the magazines. Therefore, the company cannot recognize the full amount of the payment as revenue immediately; instead, it records the payment as unearned revenue, which is a liability.

Example of Unearned Revenue

Suppose a company receives $1,200 from a customer for a one-year subscription to its newsletter. The company will recognize this payment as unearned revenue, since it has not yet earned the revenue by providing the service.

Journal Entries for Unearned Revenue

When the payment is received in advance, the company makes the following journal entry:

In this entry, the company receives $1,200 in cash, and it records a liability under Unearned Revenue because it owes the customer a year of newsletters.

As time passes, and the company delivers the newsletter each month, it will recognize a portion of the revenue as earned. The revenue is gradually “earned” over the course of the year, and the unearned revenue balance is reduced each month.

At the end of the first month, the company can recognize $100 of revenue (since the total is $1,200 for the full year, and the company is recognizing $100 per month):

The company will repeat this journal entry for each subsequent month as the service is provided.

The Key Difference Between Accrued and Unearned Revenue

While both accrued revenue and unearned revenue are related to revenue recognition, they differ in their timing and nature:

• Accrued Revenue: This is revenue that has been earned but not yet received. It is recognized when the service or product is provided, but the payment is not yet made. It’s considered an asset (Accounts Receivable) on the balance sheet.
• Unearned Revenue: This is money received in advance of providing goods or services. It represents a liability because the company owes the customer the delivery of goods or services in the future. It is recognized as the service or product is delivered.

Financial Statements Impact

Now, let’s look at how both accrued and unearned revenue appear on financial statements.

1. Accrued Revenue affects the Income Statement and the Balance Sheet. When accrued revenue is recognized, it is recorded as Service Revenue on the Income Statement. It also increases Accounts Receivable on the Balance Sheet.
2. Unearned Revenue affects the Balance Sheet as a liability. Initially, it is recorded as Unearned Revenue under liabilities. As the service is delivered and revenue is earned, it is gradually recognized on the Income Statement as Revenue, while the liability decreases.

Example: Income Statement and Balance Sheet Effects

Let’s consider a company with both accrued and unearned revenue to see how these affect financial statements:

On the Income Statement:

Practice Questions

1. What is the journal entry for accrued revenue?
   Example: A company provides $2,000 worth of consulting services in December, but the client won’t pay until January. How would the company record this transaction?
2. What is the journal entry for unearned revenue?
   Example: A company receives $5,000 in advance for a one-year subscription service starting in January. How should the company record this transaction?
3. How does accrued revenue affect the financial statements?
   Example: A company has accrued $3,000 in revenue in December. How will this affect its Income Statement and Balance Sheet at year-end?

Answers to Practice Questions

Accrued Revenue Journal Entry

Unearned Revenue Journal Entry

Accrued Revenue Impact on Financial Statements

Balance Sheet:

Increase in Accounts Receivable by $3,000.

Income Statement:

Increase in Revenue by $3,000.

Conclusion

Understanding the difference between accrued and unearned revenue is critical for accounting students as these concepts are foundational to the recognition of revenue. By recognizing when revenue is earned versus when payment is received or made in advance, businesses can maintain accurate financial records. Practice the examples, and always remember to stay consistent with the accrual basis of accounting in order to ensure that your financial statements provide an accurate reflection of the business’s financial performance.