Alright, folks, let’s kick things off with a truth bomb: behind every pristine income statement and spotless balance sheet lies a mountain of meticulous journal entries. One of these unsung heroes is the adjusting entry for unearned revenue. Now, I know what you’re thinking: “Adjusting entries? Sounds like a snooze-fest!” But stick with me, and we’ll unravel this concept together—maybe even have a laugh or two along the way. But first, let’s get a clear grip on what unearned revenue actually is.

What is unearned revenue?

Imagine this: you start a killer subscription box service for gourmet coffee beans. Customers pay you upfront for a year’s supply because, let’s face it, life without coffee is just depresso. That money you just pocketed? That’s unearned revenue. Or deferred revenue as well. In accounting speak, unearned revenue refers to the sales or service revenue a company receives before delivering the goods or services. In other words, you’ve got cash in hand but still owe your customers their caffeine fix.

Because you’ve been paid ahead of time, your company has a liability equal to that unearned revenue until you fulfill your end of the bargain. It’s like holding onto a friend’s concert ticket—you’ve got it, but it’s theirs when the show rolls around. Typically, unearned revenue is considered a current liability because you’ll settle this obligation within a fiscal year. Meanwhile, your customer records this prepayment as an asset called a prepaid expense.

Unearned revenue goes by many aliases: deferred revenue, advances from customers, deferred income, prepaid revenue, or unearned income. It’s the accounting world’s version of saying “tomato, tomahto.” Businesses that commonly deal with unearned revenue are those offering pre-orders, requiring prepayments, or running subscription-based models. Think software subscriptions, magazine deliveries, or that gym membership you swear you’ll start using next week.

Examples of products and services often paid for in advance include:

• Rent
• Insurance
• Magazines and newspapers
• Pre-ordered clothes
• Software subscriptions
• Internet and cable TV services
• Electricity (yes, keeping the lights on isn’t free!)
• Airline tickets
• Legal retainers
• Books

Read about: Adjusting entry for supplies

Does unearned revenue require an adjusting entry?

You bet it does! Unearned revenue isn’t something you can just shove under the rug and hope it sorts itself out. At the end of each accounting period—be it monthly, quarterly, or whenever you bravely face your financials—an adjusting entry is necessary. This adjusting entry for unearned revenue ensures that you recognize the portion of revenue you’ve actually earned during that period. It’s like checking off items on your to-do list; satisfying and absolutely essential for accurate financial records.

Making these adjustments keeps your financial statements honest and up-to-date. After all, nobody likes being misled—especially investors, auditors, or that nosy neighbor who’s just dying to know how your business is doing.

How to adjust unearned revenue

Adjusting unearned revenue might sound like wrestling a financial octopus, but it’s actually pretty straightforward. Just follow these two simple steps, and you’ll be navigating the accounting seas like a pro.

Determine the earned revenue

First up, figure out how much of your unearned revenue has transformed into earned revenue during the period. Let’s say you’re running that fabulous newspaper subscription service, and a customer pays you $120 for a year-long subscription. Each month, as you deliver their dose of newsprint goodness, you earn $10 of that unearned revenue. Think of it as unlocking a new level each month in a very nerdy video game.

Make the adjusting entry

Now comes the fun part—making the actual adjusting entry. You’ll debit the unearned revenue account and credit the revenue account. In plain English, you’re reducing your liability (because you owe less now) and increasing your revenue (because you’ve earned it—high five!). For our newspaper example, you’d debit unearned revenue by $10 and credit revenue by $10 each month.

Read about: Why are adjusting entries necessary?

Accounting for unearned revenue

Let’s dive a bit deeper into the nitty-gritty. Unearned revenue is money received for a promise—a promise to deliver goods or services in the future. Until you fulfill that promise, this money sits on your balance sheet as a liability. It’s like holding onto concert tickets for your friends; you’re responsible until you hand them over.

To keep everything above board, companies record these prepayments through journal entries. When the payment is received, you make an initial entry. Then, as you deliver goods or provide services, you make adjusting entries for unearned revenue. It’s all about staying organized—like Marie Kondo-ing your finances.

Most businesses use the accrual method of accounting, recognizing income when it’s earned, not necessarily when cash changes hands. So, making those adjusting entries isn’t just a good idea—it’s a must. The Securities and Exchange Commission (SEC) even lays down the law in its revenue recognition bulletin. They stipulate that before unearned revenue can be recognized as earned, several criteria must be met:

• Persuasive evidence of an arrangement exists: There’s a clear agreement between you and your customer.
• Delivery has occurred or services have been rendered: You’ve done the work or handed over the goods.
• The seller’s price to the buyer is fixed or determinable: No wishy-washy pricing here.
• Collectibility is reasonably assured: You’re confident the customer will actually pay (and not vanish into the night).

Unearned revenue journal entry

When that glorious day arrives, and your customer pays you in advance, it’s time to make the initial unearned revenue journal entry. Following the golden rule of accounting debit and credit rules, every debit has a corresponding credit.

So, you debit your cash account because, hey, your cash just increased! And you credit the unearned revenue account, acknowledging that you now have a liability to fulfill. It’s a bit like receiving a down payment on a job—you’ve got the money, but you’ve also got work to do.

Here’s how that looks:

Date	Account	Debit	Credit
DD/MM/YYYY	Cash	$$
	Unearned Revenue		$$

Adjusting entry for unearned revenue

As you deliver products or perform services, it’s time to make the adjusting entry for unearned revenue. This entry reduces your liability and recognizes the revenue you’ve earned. You’ll debit unearned revenue and credit revenue. If you’re feeling fancy and want to specify the type of revenue, you can credit sales revenue or service revenue, depending on what you’re offering.

Here’s the adjusting entry in action:

Date	Account	Debit	Credit
DD/MM/YYYY	Unearned Revenue	$$
	Revenue		$$

Adjusting entries are usually made gradually, aligning with how you fulfill your obligations. It’s like peeling an onion one layer at a time—except without the tears.

Read about: Sale of Assets journal entry examples

Unearned revenue adjusting entry examples

Example 1

Let’s say you’re running a car insurance company (living the dream!), and Mr. Gray pays you $14,400 upfront in January for a year’s worth of coverage in 2023. Time to make that initial journal entry:

Date	Account	Debit	Credit
1/1/2023	Cash	$14,400
	Unearned Revenue		$14,400

Each month, as you provide insurance coverage, you recognize the earned revenue by making an adjusting entry. Here’s how it looks for one month:

Date	Account	Debit	Credit
1/2/2023	Unearned Revenue	$1,200
	Revenue		$1,200

We arrived at the $1,200 by dividing the total payment of $14,400 by 12 months. Rinse and repeat each month, and by the end of the year, you’ve fully recognized the revenue.

Example 2

Suppose you’re a book publisher offering pre-orders for an upcoming bestseller. In January, Mrs. Jones pre-orders a copy for $50, which will be delivered in April. Here’s the initial journal entry:

Date	Account	Debit	Credit
31/1/2023	Cash	$50
	Unearned Revenue		$50

Come April, you ship the book to Mrs. Jones. Time to make the adjusting entry:

Date	Account	Debit	Credit
3/4/2023	Unearned Revenue	$50
	Revenue		$50

What is the debit and credit entry when adjusting an unearned revenue?

In case you’re still wondering, adjusting unearned revenue involves debiting the unearned revenue account and crediting the revenue account. This action reduces your liability (since you’ve fulfilled part or all of your obligation) and increases your revenue (because you’ve earned it). It’s the accounting equivalent of ticking items off your checklist and feeling that sweet sense of accomplishment.

Read about: Gain on Sale journal entry examples

Takeaways

The adjusting entry for unearned revenue is more than just a bookkeeping chore—it’s a crucial step in presenting an accurate picture of your company’s financial health. By regularly recognizing earned revenue, you avoid overstating liabilities or understating income. Nobody wants to look poorer—or richer—than they actually are. Well, maybe in Monopoly, but not in real life.

If you were to recognize all unearned revenue upfront, you’d be counting your chickens before they hatch. Your income would be overstated, and your liabilities understated for that period. Then, in future periods, your income would take an unjustified hit while expenses related to delivering the goods or services pile up. It’s a financial rollercoaster ride, and not the fun kind.

Consistent and accurate adjusting entries ensure you’re matching revenues with expenses in the right accounting periods. This practice not only keeps you in compliance with accounting principles but also builds trust with investors, creditors, and anyone else taking a peek at your financial statements. So go ahead, embrace the adjusting entry for unearned revenue—it’s the unsung hero keeping your financial house in order.