Unearned revenue is money that comes into a company before it provides a service or product to a buyer. It is a liability until the company "earns" it by delivering its obligations. Companies are required to provide four financial statements every quarter: the income statement, balance sheet, cash flow statement and statement of shareholder's equity. Unearned revenue moves through reporting statements as it turns from unearned to earned revenue.
Unearned Revenue Overview
Unearned revenue reports the amount of money a company has collected, without yet providing the goods and/or services to satisfy the obligation. Companies that typically have big unearned revenues accounts include real estate and insurance companies. For real estate companies, rent is commonly paid before the service has been provided; therefore, when a company receives rent payments, it records the rent amount as unearned revenues. Insurance companies encounter a similar situation, because they receive insurance premiums before they provide insurance protection.
Unearned Revenue Reporting
The unearned revenue amount at the end of the time period is reported on the balance sheet. The cash flows from unearned revenue are recorded on the cash flow statement. Unearned revenue flows through the income statement, as it is earned by the company. One factor to keep in mind is to make sure the prepaid revenues are collected with cash, not with an accounts receivable. Cash is preferred, as it provides more certainty that the sales are not fraudulent and the buyer is committed for the purchase of the goods.
Unearned Revenue Example
A real estate company owns one property and has one tenant. The tenant pays rent of $1,000 one month ahead of the service provided. At the beginning of each month, when the real estate company receives the payment, the company would record an increase of $1,000 to unearned revenue and an increase of $1,000 to cash. The unearned revenue of $1,000 would then turn into revenue of $1,000 at the end of the month.
Unearned Revenue Benefits
If the company has a high unearned revenue from its normal operations, then that represents a large cash flow benefit. That means the company does not need to have the capital ahead of time to allow for the provision of services and products. For investors, unearned revenue provides some idea of future reporting revenues and earnings. If unearned revenue is on the books, investors already have some idea of what future revenue will be. That will give them an advantage in trying to forecast future results.