Why is income received in advance a liability?

Definition of Income Received in Advance

Under the accrual method of accounting, when a company receives money from a customer prior to earning it, the company will have to make the following entry:

  • Debit Cash
  • Credit a liability account such as Deferred Revenue, Deferred Income, Unearned Revenue

The credit to the liability account is made because the company has not yet earned the money and the company has an obligation to deliver the goods or services (or to return the money) to the customer. Accountants will state that the company is deferring the revenue until it is earned. Once the money is earned, the liability will be decreased and a revenue account will be increased.

Example of Income Received in Advance

Assume that Jones Corporation received $10,000 from a customer on December 31 for work that will be done in the following month. On December 31, Jones Corporation will debit Cash for $10,000 and will credit Deferred Revenue for $10,000. Therefore, Jones Corporation's December 31 balance sheet's Cash will include the $10,000 and its current liabilities will report Deferred Revenue of $10,000.

After Jones Corporation delivers the goods or services, it will debit Deferred Revenue for $10,000 and will credit Sales Revenues or Service Revenues for $10,000.

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