Unearned revenue: What it is and how to record it

Imagine a customer pays you $2,000 today for work that won’t be delivered until next month. That cash increases your bank balance, but it isn’t revenue yet because you still owe the customer the service. That kind of payment is called unearned revenue, and until you deliver the product or service, it sits on your balance sheet as a liability.

What is unearned revenue?

Unearned revenue, also called deferred revenue, is payment your business receives before you’ve provided goods or services. Because you still owe the customer what they paid for, the amount must be classified as a liability on your balance sheet, not as revenue.

You’ll see unearned revenue most often in situations where customers pay upfront for access or future delivery. Common examples include annual or monthly subscriptions, prepaid services like insurance or rent, and gift cards or other prepaid cards.

Once you fulfill the obligation, your liability decreases and the payment moves onto your income statement as earned revenue.

Unearned revenue vs. earned revenue

The main difference between unearned and earned revenue comes down to timing. Unearned revenue is cash you collect before delivering a product or service, while earned revenue reflects income from work you’ve already completed.

As you deliver the service or fulfill each obligation, you gradually move amounts out of unearned revenue and into earned revenue.

Examples of unearned revenue

Businesses collect unearned revenue in many situations where customers pay upfront for access, products, or services delivered in the future. These advance payments strengthen cash flow but also create obligations your business must fulfill.

Subscription-based services

When customers pay upfront for monthly or annual subscriptions, such as gym memberships, streaming platforms, or SaaS services, that cash is unearned revenue until your business delivers the service. Subscription-based companies rely on predictable, recurring cash flow and must recognize revenue month by month as services are provided.

Prepaid products

Prepaid products include gift cards, prepaid insurance, custom-built merchandise, and high-demand items. Accepting payment in advance helps secure inventory and manage production costs, but the full amount remains a liability until the customer receives the product. Upfront payments also improve short-term cash flow for businesses with tight production cycles.

Advanced rent payments

If you receive rent before providing access to your property, the payment is recorded as unearned revenue until the tenant can use the space. Revenue is recognized gradually as the tenant occupies the property. This structure improves cash flow and ensures financial reports reflect ongoing rental commitments accurately.

Retainers and prepaid services

Many law firms, marketing agencies, consultants, and IT service providers require clients to pay a retainer as an upfront fee. Retainers help stabilize cash flow for long-term or recurring work, but each dollar remains unearned until the service is delivered. These payments must be tracked carefully to avoid misstatements and ensure accurate recognition schedules.

Journal entry: How to record unearned revenue

Accurately recording unearned revenue ensures your financial statements reflect your obligations and earned income at any point in time. A consistent process also helps maintain compliance with revenue recognition rules.

Follow these three steps to record and track unearned revenue:

Step 1: Record the initial entry

When you receive upfront cash, record:

• Debit: Cash (asset)
• Credit: Unearned revenue (liability)

Example:

A customer prepays $12,000 for a 12-month plan.

• Debit: $12,000 (increase in cash)
• Credit: $12,000 (increase in liability)

You can’t recognize this amount as revenue yet because the service hasn’t been delivered.

Step 2: Recognize revenue as you provide the service

Once you deliver the product or service, move the appropriate portion of unearned revenue to your revenue account. Subscription-based or SaaS companies often do this monthly.

Example:

A customer pays $5,000 for goods delivered in five installments. Recognize one-fifth as revenue with each delivery.

• Debit: Unearned revenue
• Credit: Revenue

Example entry for the first installment:

• Debit: $1,000 (reduces liability)
• Credit: $1,000 (earned revenue)

Step 3: Update financial statements at the end of each period

At month-end or quarter-end, adjust your statements to reflect the revenue earned and the remaining liability.

Example:

If a client paid $24,000 for a 12-month subscription, you’d recognize $6,000 after three months and leave $18,000 as unearned revenue. These adjustments keep your reporting current and accurate.

Unearned revenue journal entry examples

Unearned revenue shows up in many day-to-day accounting situations. Below are common scenarios and how the related journal entries work.

Example 1: Subscription services

A customer pays $1,200 upfront on January 1 for a six-month subscription. Because the service hasn’t been delivered, the full amount is recorded as unearned revenue. Each month, you recognize $200 of revenue ($1,200/6 months). Your liability decreases from $1,200 to $0 as each month of service is provided.

T-account illustration

The entries above flow through the ledger this way:

This shows how the liability decreases each month as revenue is earned, while the revenue account increases by the same amount.

Example 2: Prepaid consulting project

A client pays a $5,000 retainer for a three-month consulting engagement. Because the work hasn’t been completed, you must record the full payment as unearned revenue.

You can recognize this revenue in two ways:

Time-based recognition

This method divides revenue evenly across the duration of the engagement.$5,000/3 months = $1,667 per month

Milestone-based recognition

If your contract negotiations define clear deliverables, you recognize revenue when each milestone is completed. For example:

1. Milestone 1 (40% completion): Recognize $2,000
2. Milestone 2 (40% completion): Recognize $2,000
3. Milestone 3 (20% completion): Recognize $1,000

Example 3: Gift card sales

Gift cards generate unearned revenue because payment is collected before goods are delivered. If you sell $500 in gift cards, record the entire amount as a liability. When the customer redeems $300 worth of goods, you recognize that amount as revenue. The remaining $200 stays in your liability account until the customer uses it or it expires under your policy.

If $50 is expected to remain unused based on historical patterns, ASC 606 allows you to recognize that amount as breakage revenue once it becomes remote that it will be redeemed.

Revenue recognition principles and compliance

Unearned revenue ties directly to ASC 606, which requires companies to recognize revenue only when performance obligations are satisfied, not when cash is received. Applying these rules ensures revenue is recorded in the right period and reduces the risk of misstated earnings or compliance issues.

Public companies must follow GAAP or international financial reporting standards (IFRS). These standards require businesses to defer unearned revenue and recognize it when they deliver goods or services. Accurate recognition is essential for clear financial reporting and consistent tax treatment.

ASC 606 and unearned revenue

ASC 606 journal entries for revenue recognition follow a five-step model:

1. Identify the contract: Confirm that a valid contract exists with enforceable rights and payment terms
2. Identify performance obligations: Determine the distinct goods or services you’re responsible for delivering
3. Determine the transaction price: Calculate the total amount you expect to receive, including any fixed fees, variable amounts, discounts, or expected breakage
4. Allocate the price to each obligation: Assign revenue to each obligation based on its standalone selling price
5. Recognize revenue when obligations are satisfied: Record revenue once control of the good or service transfers to the customer

Unearned revenue remains a liability until your business completes these obligations.

Unearned revenue: Tax implications

At year-end, review your unearned revenue balances to ensure earned amounts have been recognized and remaining liabilities reflect work not yet completed. Missed adjusting entries can lead to overstated liabilities or understated revenue and taxable income.

Tax treatment depends on whether you use cash or accrual accounting:

• Cash-basis businesses: Revenue may be taxable when cash is received
• Accrual-basis businesses: Revenue is taxable when earned

Deferred revenue balances may also influence taxable income under IRS rules and specific revenue recognition timing.

Tracking unearned revenue best practices

Tracking unearned revenue accurately is essential for clear financial reporting and reliable revenue schedules. As your revenue streams grow—especially with multiple subscription plans, retainers, or prepayments—manual tracking becomes harder and increases the risk of errors.

Set up a reliable accounting system

A clean system prevents misstatements and simplifies audits. As you set up your accounting framework, keep these practices in mind:

• Create separate liability accounts for each revenue type (subscriptions, gift cards, retainers)
• Establish automated recognition schedules so revenue moves monthly without manual work
• Use automation software that syncs billing, payments, and accounting to reduce errors and improve visibility

A strong setup helps you recognize revenue on time and forecast upcoming obligations. It also makes it easier to automate routine tasks as your business scales.

Avoid common mistakes

Even with good processes in place, unearned revenue can become inaccurate if certain pitfalls slip through. Keep these oversights in mind:

• Recognizing revenue too early, especially for long-term contracts
• Forgetting to post monthly adjusting entries
• Mixing different types of unearned revenue in one account, which complicates accounting reconciliation
• Not reviewing contract terms regularly, which can lead to incorrect timing of revenue recognition
• Failing to update schedules when customers upgrade, cancel, or modify services

Manage your unearned revenue with automated tools

Unearned revenue affects your reporting, cash flow visibility, and how confidently you can make financial decisions. When it’s tracked accurately, you get a clearer view of your obligations and the income you’ve already earned.

If you’re ready to simplify the process, Ramp can help. With platforms like Ramp, you can automate revenue tracking, eliminate manual data entry, and record unearned and earned revenue with precision. Centralize your spend, billing, and accounting so you can manage unearned revenue confidently and focus on running your business.