Unearned income or Customer Deposits may appear to be a problem on the balance sheet, but it has numerous advantages for small business owners. To cover last month’s expenses, you’ll need an advance on a new project. Are you unsure whether retainers will give you the cash flow you require? Are you concerned that requesting deposits would annoy customers?
If you’re a small business owner, you’ve probably already considered at least one of these issues. Advance payments, retainers, and deposits are all ways to collect unearned money, which is a significant burden on your books.
The Unearned Revenue is not “Revenue” until it’s realized
Despite its name, unearned revenue is not actually revenue—yet. That’s because it’s revenue you haven’t actually earned. You collect it in advance, as prepayment before completing a project or delivering a service for a client. Which means it will initially go under your liability account.
It also goes by other names, like deferred income, unearned income, or deferred revenue.
Some common examples of unearned revenue include:
- Service contracts paid in advance
- Legal retainers paid in advance
- Advance rent payments
How to record unearned revenue
When doing your bookkeeping, how do you record unearned revenue? Since unearned revenue hasn’t actually been earned yet, it starts out as a liability on your books.
For example: Imagine charging your client a $2,000 advance as an advance payment on a sales order.
- Go to Options > Click on “Record a Deposit”
- A $2,000 credit would be recorded as unearned revenue on your balance sheet under current liabilities. And since assets need to equal liabilities in the same period, you’ll also need to debit your cash account by $2,000 under current assets.
Here’s what the journal entry would look like:
Record a Customer Deposit
|Unearned Revenue/Customer Deposits||–||$2,000|
What does this mean for you?
You just gained $2,000 in the cash account that you can use to keep your business operations up and running! As great as this sounds, don’t forget that this cash hasn’t been realized (i.e. earned).
And any revenue that has not been realized (i.e. unearned revenue) will not appear on your income statement just yet; that is, not until you’ve delivered on the projects and/or services you’ve promised.
Once the sales order is shipped, an invoice will be generated and the customer deposit will be applied on to the invoice. This means you’ll debit the unearned revenue account by $2,000 and credit the revenue account by $2,000.
Here’s what that journal entry would look like:
Apply Customer Deposit
|Unearned Revenue/Customer Deposit||$2,000||–|
Now that this revenue is realized, you can record it on your income statement.