Effect of Unearned Revenue on Cash Flow

Good business involves a certain element of trust. This trust may manifest in receiving a customer’s money in advance of delivering goods and services. This involves the accrual of unearned revenue, sometimes referred to as deferred revenue.

In this post, we’ll run through precisely what’s meant by unearned revenue and the effect it can have on your cash flow statement.

What is unearned revenue?

Businesses may sometimes receive a portion of payment, or payment in full, before providing goods or services to a customer. This results in the business receiving unearned revenue, as they have not yet carried out a service in exchange for the received revenue.

Unearned revenues are treated as liabilities in the balance sheet at the time they are received, as at this moment in time, it is money owing.

Conversely, earned revenue refers to the revenue received subsequent to having provided goods or services to a customer.

Unearned revenue example

Let’s imagine that a gardening company signs a contract with a private institution to deliver gardening services over a period of three months at a cost of $5000 AUD. The gardening company charges an advanced payment of 25% of the total contracted amount.

This 25% ($1250) would be treated as unearned revenue and a liability, because it was received in advance of the provision of any services. It is classified as a liability in the balance sheet as it is expected to be delivered within 12 months of the reporting date.

How is unearned revenue recorded in bookkeeping?

When first entered in the books, unearned revenue is noted as a debit to the cash account and a credit to the unearned revenue account. This means the business will view it as an influx of cash, but on credit. It’s essentially a prepayment, but nonetheless results in cash inflow.

Once the business fulfils the service they’ve been paid for, the entry is adjusted and the unearned revenue account is debited, while the service revenues account is credited.

This means unearned revenue is noted in the books on two occasions: when it’s received and when it’s actually earned.

Does unearned revenue go on your income statement?

Unearned revenues are noted on an income statement as income received, i.e., when the services it is intended to compensate for are performed.

In order that the public and shareholders understand the business’s transactions, all businesses are required to put together transparent financial statements on an annual basis, which include the statement of cash flow outlined according to the IAS 07.

A statement of cash flow is a financial statement shown to the Board of Directors at the Annual General Meeting (AGM) along with other key financial information, including an income statement and balance sheet.

It must be set up according to IAS 7 guidelines and clearly present all cash transactions which have taken place over a given period.

Effects of unearned revenue on statement of cash flow

As already mentioned, unearned revenue results in an influx of cash flow as it is essentially an advanced payment.

Unearned revenue is recorded in the cash flow statement when it is received and recorded in the balance sheet as a liability. It is then recorded in the income statement subsequent to the service being carried out in exchange for the payment.

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