Definition of Unearned Income
Unearned income or deferred income is a receipt of money before it has been earned. This is also referred to as deferred revenues or customer deposits. The unearned amount is initially recorded in a liability account such as Deferred Income, Deferred Revenues, or Customer Deposits. As the amount is earned, the liability account is reduced and the amount earned will be reported on the income statement as revenues.
Example #1 of Unearned Income
A lawn service company offers customers a special package of five applications of fertilizers and weed treatments for $300. However, the customer must prepay in December for the five treatments that will be done between April and September. When the company receives the $300 in December, it will debit the asset Cash for $300 and will credit the liability account Unearned Revenues. Since these are balance sheet accounts (and since no work has yet been performed), there are no revenues to be reported in December. In April when the first service is provided, the company will debit the liability account Unearned Revenues for $60 and will credit the income statement account Service Revenues for $60. At the end of April, the balance sheet will report the company's remaining liability of $240. The income statement for April will report the $60 that was earned. The $60 entry is referred to as an adjusting entry and the same entry will be recorded when each of the remaining four treatments are provided.
Example #2 of Unearned Income
A company informs a new 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 in December. When the special order begins and is completed in January, the company will debit the liability account for $5,000 and will credit a revenue account.