Unearned revenue is the amount that the company owes to the customer until an ordered product or service is delivered to him. The unearned revenue counts as a liability as the product remains refundable and cannot turn into income until the customer receives a product or a service in full.
Explanation:
In accounting, unearned revenue is also called deferred revenue; however, the deferred revenue refers to the payment that was made in advance, a pre-payment that a company will supply later. Unearned revenue is the amount that the company owes to the customer until he receives the goods that he ordered. Therefore, if the customer paid for the product, but have not received it yet, the company owes paid amount to the customer.
The payments that were made before the product is delivered cannot be recognized as revenue as the service has not been used by the customer even though he paid money for it. Therefore, the payment is still refundable and cannot count as actual revenue.
According to the Generally Accepted Accounting Principles (GAAP), all the revenues must be recorded when earned, even though the cash can be received later. Such payments are reflected as a liability on the balance sheet as it represents the debt owed to the customer. When the service is delivered, it becomes reflected in the income statement. However, the company receives receipts, which leads to an increase in the cash flow that allows using the money. Therefore, unearned revenue increases cash flow and liability at the same time.
The magazine subscription is a clear example of an unearned revenue as the customer pays for the year subscription, even though he does not receive all the magazines right away. The readings become available to him every month, and until the subscription is provided in full, a year-payment counts as a liability.
