In small business accounting, some concepts can be trickier than simply recording assets, liabilities, and transactions. Some companies receive advances in payments before actual services are performed. In accounting, this is called Unearned Revenue. Unearned revenue must be reported in order for companies to comply with GAAP* principles. When the company receives an advance, it increases the Cash account and also increases a current liability account, named something like Unearned Revenue. Later when the company earns the revenue, it decreases the Unearned Revenue liability account and increases its appropriate revenue account (to show that the company has actually earned the revenue). In this post, we will show an example of how companies report unearned revenue in financial documents.
Let’s look at an example. Company XYZ Inc receives an advance of $1,000 from ticket sales in cash. We can use this 4 step process to highlight the steps when recording a journal entry.
|Basic Analysis||The asset cash increased $1,000
The liability unearned ticket revenue increased $1,000.
|Equation Analysis||Assets = Liabilities + Stockholder’s Equity
|Debit-Credit Analysis||Debits increase assets: Debit Cash $1,000
Credits increase liabilities: Credit Unearned Ticket Revenue
|Journal Entry||September 1
Unearned Ticket Revenue 1,000
Step 1: Basic Analysis. The first step is the basic analysis of the economic event. In our case, an asset increased $1,000 and a liability increased $1,000.
Step 2: Basic equation analysis. The basic accounting equation must always balance. In our case, an asset and a liability both increased, so the equation will balance.
Step 3: Debit/Credit Analysis. Understanding which account to credit and which account to debit is critical to creating journal entries and other financial information. In this example, Cash needs to be debited $1,000 and Unearned Ticket Revenue needs to be credited $1,000.
Step 4: Create the Journal Entry. (See Above)
What Happens When the Company Earns the Revenue?
After the company earns the revenue, another accounting transaction needs to be recorded. Let’s look at an example using the same company and same numbers as before.
Later on, Company XYZ Inc has earned the revenue by hosting the event.
Now that the revenue has been earned, an adjusting entry must be made because the liabilities are overstated, while revenues are understated. (Adjusting entries make sure that the financial data is correct after another economic event occurs that affects those specific accounts.)
Since unearned revenues recorded in liability accounts have been earned, the adjusting entry would look like this:
(A liability account is debited and a revenue account is credited.)
|Journal Entry||September 29
Unearned Ticket Revenue 1,000
Ticket Revenue 1,000
* Learn more about GAAP, unearned revenue, and other small business accounting concepts in our Accounting Tutorial.
**Note: This is meant to be an introduction to Unearned Revenue in small business accounting. When filling out complicated financial information, it is best to check with an accountant in order to ensure correct documents.