Question

How does unearned revenue arise? Why can it be classified properly as a current liability? Give three examples of business activities that result in unearned revenues.

Answer 1

1. Companies may consider a revenue as realized after receiving cash from customers, but may not recognize it in accounting books as earned until later based on revenue recognition principle. Unearned revenues often relate to products or services that companies deliver or perform over multiple accounting periods. Unearned revenue arises when a company receives cash or other assets as payment from a customer before conveying the goods or performing the services which it has committed to the customer.
2. Unearned revenue is assumed to represent the obligation to the customer to refund the assets received in the case of non performance or to perform according to the agreement and thus earn the unrestricted right to the assets received. While there may be an element of unrealized profit included among the liabilities when unearned revenues are classified as such, it is ignored on the ground that the amount of unrelized profit is uncertain and usually not material relative to the total obligation.
3. Unearned revenue arise from the following activities:
a) The sales by a transportation company of tickets that may be exchanged or used to pay future fares.
b) The sale by a restaurnat of meal tickets that may be exchanged or used to pay future meals.
c) The sale of gift certificates by a retial store
d) The sale of subscription to magazines.