Unearned income or unearned revenue occurs when a company receives money before the money is earned. This is also referred to as deferred revenues or customer deposits. The unearned amount is recorded in a liability account such as Unearned Revenues, Deferred Revenues, or Customer Deposits. After the amount has been earned, the liability account is reduced and a revenue account is increased.
Example 1. A lawn service company offers customers a special package of five applications of fertilizers and weed treatments for $200 if the customer prepays in March. The service will be provided in April, May, June, July, and September. When the company receives $200 in March, it will debit the asset Cash for $200 and will credit the liability account Unearned Revenues. Since these are balance sheet accounts (and since no work has yet been performed), no revenue is reported in March. In April when the first service is provided, the company will debit the liability account Unearned Revenues for $40 and will credit the income statement account Service Revenues for $40. At the end of April, the balance sheet will report the company's remaining liability of $160. The income statement for April will report that $40 was earned. The $40 entry is referred to as an adjusting entry and the same entry will be recorded in May, June, July, and September.
Example 2. A company informs a customer that a $5,000 deposit is required before it will begin work on the customer's special order. The customer gives the company $5,000 on December 28 and the company will begin work on the special order on January 3. On December 28 the company will debit Cash for $5,000 and will credit a liability account, such as Customer Deposits (or Unearned Revenues or Deferred Revenues) for $5,000. No revenue is reported in December for this special order since the company did not perform any work. When the special order is completed in January the company will debit the liability account for $5,000 and will credit a revenue account.
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