Adjusting Entries: Unearned Revenue - Online Tutor, Practice Problems & Exam Prep

Unearned revenue is a liability that arises when cash is received from customers before services are performed. For example, if a tutor receives $1,000 for 20 hours of tutoring, they debit cash and credit unearned revenue. As services are rendered, the unearned revenue decreases, and revenue is recognized. If 12 hours are used, the tutor earns $600, adjusting unearned revenue to $400. This process illustrates the transition from cash-basis to accrual accounting, ensuring accurate revenue recognition based on services performed.

Adjusting Journal Entries: Unearned Revenue (Accrual Accounting Method)

Alright. Our next adjusting entry is related to unearned revenue. Let's check it out. So remember, adjusting entries include the deferrals, the accruals, and depreciation. We're still talking about deferrals at this point. Okay? So unearned revenue is going to be a deferral type adjusting entry. So let's discuss what unearned revenue is. This is when we receive cash from the customer before delivering goods and services to the customer. So this is where the customer pays us in advance, right? The cash is received, but we haven't done anything for them yet, right? So what do you think this is? Think about those technicalities there. Unearned revenues, what kind of account is that? So think of the situation. In this situation, the customer has given us money. We've received money from the customer, but we haven't done anything for them yet. In this case, we owe them a service, right? They've paid us for something, and in the future, we are going to have to do that something for them. So since we owe them something, since we have to do something for the customer, we have a liability. Unearned revenues are liabilities because we have received payment from the customer, right? But we have not performed for them yet. Okay? So we are liable to perform whatever we need to do for the customer. So just like everything else, we've got these two important dates. So let's think about the important dates and let's start here in the blue boxes and then we'll talk about the cash basis to accrual in the next video for the red boxes. Okay. So let's start here. The first date is the cash receipt date. This is the day the customer actually pays you, even though you haven't done anything for them yet. Okay? So on January 15th, a student paid the tutor $1,000 in advance for 20 hours of tutoring. Okay? So we're gonna think of it from the tutor's perspective. Not from the student's perspective. We're thinking from the tutor, the business, they received $1,000. Right? So he received $1,000. So he's going to debit cash. Right? He received $1,000, but what about the credit? The credit isn't going to be revenue. We haven't done anything for the customer yet. All we did was receive this money. So we're going to credit unearned revenue, right? And this is a liability because at some future date, we're going to have to tutor this student, and he's not going to pay us any more money. He already paid us, right? So this unearned revenue is we're going to earn it as we tutor the student. Cool? So that would be our entry. Debit cash for $1,000 because we received cash. And credit unearned revenue, a liability, which we will earn over time as we tutor the student.

So here we go on the adjusting date. Adjust the unearned revenue account based on the amount of revenue earned, right? There was a bunch of unearned revenue, but we're going to earn some of it as we perform our service. So on January 31st, the student still had 8 hours of tutoring prepaid. So notice, they could tell you this a few different ways. They could tell you how many hours the student used up or they could tell you how many hours are left, right? They told us in this case, there are 8 hours left. So we can infer that from the 20 hours that they paid for minus the 8 hours left, well, there were 12 hours used up, right? He used up 12 of those prepaid hours. So from our perspective, the tutor's perspective, we've earned revenue for 12 hours of work, right? There are still 8 hours of work we still have to perform, but there are 12 hours that we've earned, right? So the one more thing we need to know is how much revenue do we get per hour? Let's do that up here. We had $1,000 paid to us for 20 hours of tutoring, right? $1,000 divided by 20. Well, that's going to give us $50 an hour, right? $50 an hour for that private tutoring. Man, tutoring sounds like a great deal now, Alright. So $50 per hour and they've used up 12 hours of their tutoring, Right? So $50 times the 12 that they've used up is going to be $600, right? So $600 is the revenue that we've earned. We've tutored the student for 12 hours, we've earned $600 of this revenue. So we are going to, in this case, debit our unearned revenue, right? Because since we performed for this customer, our liability to them is less, right? We've performed a lot of this for them, so there's no way we still owe them $1,000 worth of services. We owe them less. We need to decrease that by the $600. So this debit to unearned revenue is decreasing the balance from $1,000 down to $400, right? $1,000 minus the $600. And then we earned revenue. So we're going to have a credit to revenue for $600, right? This is revenue that we actually earned and notice that this revenue $600 is the 12 hours times the $50, right? So that is the revenue we've earned so far and that is going to be our total revenue down here, $600 and our unearned revenue, well, that's the $1,000 minus the $600 we've earned, there's still $400 in unearned revenue. So if you're going to show our balance sheet, there would be a liability on the balance sheet, for $400 in unearned revenue. Cool? Let's pause here and then we'll do the cash basis to accrual in these red boxes on the right.

Adjusting Entries: Unearned Revenue (Cash Basis to Accrual Method)

Alright. So let's start with the cash basis to accrual method over here on the right. So I'm just going to write that in here. Cash basis to accrual. So remember from a cash basis, we earn our revenue when that cash is received, right? We received $1,000 in cash. Hey, we're feeling good. We earned that revenue. So cash would go up by $1,000, right? We received $1,000 in cash, but we're going to directly credit our revenue. We're going to say we earned all this revenue already from a cash basis, right? And you can see why that's a little trickier when we think about it in the long term.

So the idea here is that we've earned revenue of $1,000, right? But from an accrual basis, we didn't earn all that revenue yet, right? We need to adjust that down to the correct amount. So the correct amount in this case is again going to be the same amount, the same logic we used in the other sections where we had $1,000 earned divided by 20, gave us a $50 an hour rate, right? And we found out that there were 12 hours that we actually tutored them, right? The students still had 8 hours of tutoring prepaid. They paid for 20. So that means they had to use up 12 of them.

So what does that tell us? It tells us that our revenue should actually be $600, right? The $600, which was the $50 an hour times 12 hours used up, that should be the amount of revenue we actually earned. But what does it say our revenue is right now? Our revenue is currently sitting at $1,000. We need to bring it down to $600, right? So since revenues go up with a credit, they go down with a debit. So we're going to debit revenue for $400 in this case, right? Because it was at $1,000, and we need to bring it down to $600. So we're going to debit it by $400, that brings the revenue account to a credit balance of $600, which is what we want, right? The amount we've earned.

And what about this $400? Well, this is unearned revenue, right? We got paid for this $400, but we haven't earned it yet. And that's that same $400 for those 8 hours that are still not used up. Okay. So our revenue account is sitting at that $1,000 minus the $400, which gets us to the correct balance of $600 in this case, and our unearned revenue we didn't touch till here at the end where we got a credit balance of $400. So notice in both cases on the left and the right, we got to the same final revenue and unearned revenue balances, alright? Let's go ahead and move on to the next video.

In May, the Party Company received $4,000 as a deposit for a party that was occurring in November. In October, the Party Company received a $5,000 deposit for a party occurring in February of the following year. The company recorded both of these payments into the Unearned Revenue account and did not adjust the account after recording the payments. The adjusting entry at December 31 would include:

• A. Debit Revenue $4,000; Credit Unearned Revenue $4,000
• B. Credit Revenue $4,000; Debit Unearned Revenue $4,000
• C. Debit Revenue $9,000; Credit Unearned Revenue $9,000
• D. Credit Revenue $9,000; Debit Unearned Revenue $9,000

Here’s what students ask on this topic:

What is unearned revenue and how is it recorded in accounting?

Unearned revenue is a liability that arises when a business receives cash from customers before delivering goods or services. For example, if a tutor receives $1,000 for 20 hours of tutoring in advance, they would debit cash and credit unearned revenue. This entry reflects the obligation to provide future services. As the services are performed, unearned revenue decreases, and revenue is recognized. For instance, if 12 hours of tutoring are completed, the tutor would debit unearned revenue and credit revenue for the amount earned, ensuring accurate revenue recognition.

How do you adjust unearned revenue in accounting?

Adjusting unearned revenue involves recognizing the revenue earned over time. Initially, when cash is received, it is recorded as a liability (unearned revenue). As services are performed, the unearned revenue account is debited, and the revenue account is credited. For example, if a tutor received $1,000 for 20 hours of tutoring and completed 12 hours, they would debit unearned revenue by $600 (12 hours x $50/hour) and credit revenue by the same amount. This adjustment ensures that the financial statements accurately reflect the revenue earned and the remaining liability.

What is the difference between cash basis and accrual basis accounting for unearned revenue?

In cash basis accounting, revenue is recognized when cash is received, regardless of when services are performed. For example, if a tutor receives $1,000 in advance, they would recognize the entire amount as revenue immediately. In contrast, accrual basis accounting recognizes revenue when it is earned. Using the same example, the tutor would initially record the $1,000 as unearned revenue (a liability). As tutoring sessions are completed, the tutor would adjust the accounts to recognize the earned revenue, ensuring that financial statements accurately reflect the timing of revenue recognition.

Why is unearned revenue considered a liability?

Unearned revenue is considered a liability because it represents an obligation to provide goods or services in the future. When a business receives payment in advance, it has not yet earned the revenue and must fulfill its commitment to the customer. For example, if a tutor receives $1,000 for future tutoring sessions, this amount is recorded as unearned revenue. As the tutor provides the tutoring sessions, the liability decreases, and revenue is recognized. This accounting treatment ensures that the financial statements accurately reflect the business's obligations and earned revenue.

How do you calculate the amount of revenue earned from unearned revenue?

To calculate the amount of revenue earned from unearned revenue, you need to determine the rate per unit of service and the number of units of service provided. For example, if a tutor receives $1,000 for 20 hours of tutoring, the rate is $50 per hour ($1,000 ÷ 20 hours). If the tutor has completed 12 hours of tutoring, the revenue earned is $600 (12 hours x $50/hour). The unearned revenue account is then adjusted by debiting it for $600 and crediting the revenue account for the same amount, reflecting the earned revenue.