The accruals concept in accounting requires companies to record income and expenses when they occur. In the past, companies only recognized these items if they involved a cash flow. However, the accruals concept changed that treatment. While this made accounting straightforward and more transparent, it also created issues with understandability. Furthermore, it resulted in various new accounting treatments.
The accruals concept usually applies to the balance sheet and income statement. However, companies still report their cash activities through the cash flow statement. Companies can prepare this statement in two formats, direct and indirect. However, the latter is more prevalent among most companies. While the statement of cash flows only involves cash activities, it also includes some accrual concept items.
One particular area in accounting that falls under the accruals concept is unearned revenues. While these transactions are not as common for all companies, they may occur. However, most people may wonder how unearned revenues get reported on the cash flow statement. Before discussing that, however, it is crucial to understand what these revenues are.
What are Unearned Revenues?
Unearned revenues go against the typical sale transactions. Usually, companies sell a product or service to a customer. In exchange, the customer pays the company at the time. In some cases, it may also involve a future payment. Either way, this transaction entails delivering a product or service before the settlement. Therefore, this income becomes earned revenues for the company.
However, companies may also receive a settlement in advance. This transaction does not involve the delivery of a product or service at the time. Instead, the company delivers those items in the future. In this case, the revenues become “earned” later. Nonetheless, accounting principles require companies to record the receipt from the customer at that time. Therefore, they term it as unearned revenues.
Therefore, unearned revenues refer to the payment received from customers in advance for future sales. Companies may also use deferred revenues or advance from customers to denote it. Essentially, unearned revenues involve the settlement before a company meets its performance obligation. Accounting standards do not allow companies to treat this settlement as income until delivering the product.
Overall, unearned revenue refers to cash received by a company for a product or service yet to be delivered. The company getting this cash must provide the item at a future date. However, when this transaction occurs, it cannot recognize as income. The company cannot wait to record the receipt when it delivers the product or service. Consequently, it must account for the cash as unearned revenues.
Is Unearned Revenue an Asset or Liability?
If unearned revenue is not an income, most people assume it should be an asset or liability. However, it does not meet the definition for the former classification. In accounting, assets include resources owned or controlled by an entity. Unearned revenue includes cash which is an asset. However, it does not fall under the category. Similarly, it does not constitute an inflow of economic benefits in the future.
Liabilities are obligations from past events which result in future compensation. In other words, they require an outflow of economic benefits in the future. In this definition, the settlement does not include cash or monetary payments only. It may also consist of compensating the party through other means. In this case, these means include the products or services delivered by the company.
Unearned revenues meet the definition of liabilities better. Essentially, these revenues are obligations to deliver products or services in the future. They also exist due to past events, which is the receipt of cash or monetary amounts from a customer. Therefore, companies record unearned revenues as liabilities in the balance sheet.
Although it has “revenues” in the name, unearned revenues do not constitute income. Therefore, it does not appear on the income statement. Once the company delivers products or services, it can treat them as income in the income statement. Before that, however, unearned revenues stay on the balance sheet. Similarly, these revenues can also appear on the cash flow statement.
How to Treat Unearned Revenues on Statement of Cash Flow?
Usually, companies do not report their revenues directly in the cash flow statement. These revenues come included in the net profits brought from the income statement. Similarly, the adjustments from account receivables also support the cash payments from revenues. Unearned revenues, in contrast, are different. As mentioned above, these revenues involved a cash payment. Therefore, reporting them in the cash flow statement is critical.
The cash flow statement segregates cash flows into three activities. Under accounting standards, they include operating, investing, and financing. Unearned revenues are a part of a company’s operations. Therefore, they fall under the first category of activities. Companies report their unearned revenues in the cash flow from operating activities. However, this process does not transpire directly. Instead, it occurs through a difference between opening and closing balances.
As a part of current liabilities, unearned revenues get the same treatment as other items under the heading. The same happens for any account balances under current assets. Essentially, a company must calculate the difference between the opening and closing balances for them. Based on the result, they can establish whether it is an outflow or an inflow.
For current liabilities, an increase in balance constitutes a cash inflow. On the other hand, a decrease signifies cash outflows. The opposite will apply to current assets. Since unearned revenues fall under the former category, they follow similar rules. If a company’s deferred revenues increase, it will constitute a cash inflow. Similarly, a decrease in the balance will signify a cash outflow.
Therefore, companies report unearned revenues on the under operating activities. However, this process is not direct. Companies treat unearned revenues as other items in the current liabilities and assets. This treatment entails calculating the difference between opening and closing balances. Based on that, companies can determine if it is a cash outflow or inflow.
How Does Unearned Revenues Report on Statement of Cash Flow?
From the above treatment of unearned revenues, it is possible to understand how to report it. As mentioned above, companies include unearned revenues under operating activities. Similarly, the treatment involves calculating the difference between opening and closing balances.
Therefore, unearned revenues can appear on the statement of cash flows as follows.
|Net profits / (losses)
|XXXX / (XXXX)
|Non-cash item adjustments
|XXXX / (XXXX)
|Additions / subtractions from cash
|– (Increase) / Decrease in current assets
|(XXXX) / XXXX
|– Increase / (Decrease) in in unearned revenues
|XXXX / (XXXX)
|– Increase / (Decrease) in current liabilities
|XXXX / (XXXX)
|Net cash flows from operating activities
|XXXX / (XXXX)
In the above report, unearned revenues only require one adjustment. It will not constitute a non-cash adjustment. As a part of current liabilities, companies must include these in the calculations. As mentioned above, if the balance in the account has increased, it will constitute a cash inflow. If it has decreased, it will be a cash outflow.
For example, a company, ABC Co., had an opening unearned revenues balance of $100,000. During the year, it received advances from customers amounting to $500,000. However, it also cleared unearned revenues of $400,000 during the year. Therefore, the closing balance was $200,000. In the cash flow statement, unearned revenues will be as follows.
Increase / (Decrease) in unearned revenues = Closing unearned revenues – Opening unearned revenues
Increase / (Decrease) in unearned revenues = $200,000 – $100,000
Increase / (Decrease) in unearned revenues = $100,000
In the above case, the $100,000 difference in unearned revenue balances will be a cash inflow. Despite the actual $500,000 received from customers, the report under statement of cash flows will differ.
Unearned revenues represent amounts received from customers in exchange for future sales. These items do not constitute income but rather liabilities. Primarily, unearned revenues impact the balance sheet and cash flow statement. In the latter, these revenues are a part of the current liabilities difference calculation. Unearned revenues appear under cash flows from operating activities in the cash flow statement.