A common situation where unearned revenue occurs is when customers provide a company with a deposit

When you first receive the deposit, even though you receive the cash, you cannot recognize revenue because you still need to deliver the good or service

Let’s walkthrough an example:

A customer provides an accounting firm with a deposit of 200,000 Rwf in January for accounting services to be provided in February.

Qs: Thinking back to our liability definition. Can someone remind us the 3 criteria that need to be met?

Qs: Using those criteria, why is it a liability?

When the company receives the 200,000 deposit, what is the impact on the accounting equation?

                          +200,000                 +200,000

The company obtains one asset (cash) but owes the customer the service (liability).

Qs: What is the impact on the accounting equation?

There is no impact on equity as we have received an asset, but we owe a liability of the same amount.

We increase cash (asset), so we debit

We increase unearned revenue (liability), so we credit

ASK: What is the associated journal entry?

It is now February and the firm delivers the accounting services. What is the impact on the accounting equation?

                                                           -200,000                +200,000

When the firm delivers the services, they no longer have an obligation to the customer. Therefore, they reduce unearned revenue (liability) and recognize revenue (increase in equity).

Qs: What is the impact on the accounting equation?

Qs: Why do we now have an increase in equity?

We have satisfied our obligation and now no longer owe anything to the client. We have earned the revenue.

We decrease unearned revenue (liability), so we debit

We increase revenue (revenue), so we credit

Qs: What is the associated journal entry?