Unearned revenue, deferred payment examples defined and explained electricity magnetism

Most businesses worldwide implement accrual accounting with a double entry accounting system. They choose this approach even though it is more complex and more difficult to use than the simpler alternative, single entry accounting. Using a double entry system, for instance, requires users to have at least some level of formal training in accounting. The double-entry user must, for instance, have a solid grasp of concepts such as debit, credit, Chart of accounts, and the so-called Accounting equations. By contrast, just about anyone who can arrange numbers in a table and add and subtract can set up and use a single entry system.

Public companies and almost all large firms nevertheless choose double entry and accrual accounting. This is because it is simply impossible for them to meet government reporting and record-keeping requirements using a single-entry system alone. And, they choose this approach because it enables them to track manage revenues and expenses, as well as liabilities, owners equities, and assets. By contrast, Single entry accounting serves only for managing cash outflows and inflows. Unearned Revenues Help Implement the Matching Concept

The unearned revenue concept serves to help firms turn cash payments into revenue earnings over a period of time. In other words, with accrual accounting, customer prepayments do not become revenue earnings immediately. Regardless of when customers pay cash, revenues do not qualify as revenue earnings until the seller delivers the goods or services.

• If the sale has been closed but the customer has not yet paid, the seller can claim revenues earned only if seller considers the revenues to be realizable. This means the seller has reasonable expectation that cash payment will actually be received.

Because the matching concept mandates that firms recognize revenues in the same period with the expenses that brought them, prepayment and deferred payment situations present a special challenge to the company’s bookkeepers and accountants. This because it is possible for actual payment and actual delivery.

For compliance with the matching concept, both the seller and the buyer record the first part of the sale event, as it occurs, with two journal entries. Example journal entries of this kind appear above in Exhibit 1 and 2. Exhibit 2 represents such entries when there is a time lapse between parts sale parts 1 and 2.

Later, when part 2 of the sale occurs, buyer and seller each make another pair of journal entries, such as those shown in Exhibit 3. The seller cannot claim revenue earnings and the buyer cannot claim expense payments, until both parts of the sale transaction complete.

In the deferred payment situation, the seller who has not yet been paid records accrued revenues (also called accrued assets or unrealized revenues). These are revenues earned by the seller for delivery of goods and services for which the seller has not yet been paid.

• Interest payable for a bank loan can be an accrued expense. Accrued expenses are first entered into the journal as a liability until paid, at which time the liability account is debited (reduced) and an asset account, such as cash, is credited (decreased).