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Chapter 13: Question 10Q (page 715)

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

Short Answer

Expert verified

Unearned revenue arises when a company receives the payment for a good or service that is yet to be delivered or rendered respectively.

The company decreases the balances in the unearned revenue account and increases the balance in the revenue account, as the revenue is earned by the company. Thus, the unearned revenue account is usually classified as a current liability on the balance sheet.

Examples of unearned revenue are prepaid rent, prepaid insurance, annual subscriptions for a software license.

Step by step solution

01

Definition of Unearned Revenue

Unearned revenue occurs when cash is obtained by the company as a payment from a customer before producing goods or rendering the services as promised to the customer. However, it is regarded as a prepayment for goods and services that will be conveyed at a future date.

02

Classification of unearned revenue as a current liability

Unearned revenue is an assumption made to show the obligation made to the customer to refund the assets received in advance in case of the nonperformance of the aforesaid contract, in turn earning the rights over the assets received. However, there might be an element of unrealized profit included in the liabilities. When the unearned revenues are grouped as such, it is ignored fact that the amount of unrealized profit holds uncertain and usually not material in relation to the total obligation.

03

Examples of Unearned Revenues

  • The amount paid by the company for insurance in advance.
  • The amount paid by the company for services in advance.
  • The amount paid by the company for expenses in advance.

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Most popular questions from this chapter

E13-10 (L03) (Warranties) Soundgarden Company sold 200 color laser copiers on July 10, 2017, for \(4,000 apiece, together with a 1-year warranty. Maintenance on each copier during the warranty period is estimated to be \)330.

Instructions

Prepare entries to record the sale of the copiers, the related warranty costs, and any accrual on December 31, 2017. Actual warranty costs (inventory) incurred in 2017 were $17,000.

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(Available-for-Sale and Held-to-Maturity Debt Securities Entries) The following information relates to the debt

securities investments of Wildcat Company.

1. On February 1, the company purchased 10% bonds of Gibbons Co. having a par value of \(300,000 at 100 plus accrued interest.

Interest is payable on April 1 and October 1.

2. On April 1, semiannual interest is received

3. On July 1, 9% of bonds of Sampson, Inc. were purchased. These bonds with a par value of \)200,000 were purchased at 100

plus accrued interest. Interest dates are June 1 and December 1.

4. On September 1, bonds with a par value of $60,000, purchased on February 1, are sold at 99 plus accrued interest.

5. On October 1, semiannual interest is received.

6. On December 1, semiannual interest is received.

7. On December 31, the fair value of the bonds purchased February 1 and July 1 were 95 and 93, respectively.

Instructions

(a) Prepare any journal entries you consider necessary, including year-end entries (December 31), assuming these are

available-for-sale securities.

(b) If Wildcat classified these as held-to-maturity investments, explain how the journal entries would differ from those in part (a).

E13-11 (L03) (Warranties) Early in 2017, Sheryl Crow Equipment Company sold 500 Rollomatics during 2017 at \(6,000each. During 2017, Crow spent \)20,000 servicing the 2-year assurance warranties that accompany the Rollomatic. All applicabletransactions are on a cash basis.Instructions(a) Prepare 2017 entries for Crow. Assume that Crow estimates the total cost of servicing the warranties will be \(55,000 for2 years.(b) Prepare 2017 entries for Crow assuming that the warranties are not an integral part of the sale (a service-type warranty).Assume that of the sales total, \)56,000 relates to sales of warranty contracts. Crow estimates the total cost of servicingthe warranties will be $55,000 for 2 years. Estimate revenues to be recognized on a straight-line basis.
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