Unearned income is income that was received in advance and related to future accounting periods. Therefore, it should be recorded as income for future periods. Most often, deferred income is a prepayment received for a product or service. As long as the goods are not shipped, and the services are not provided, these revenues are recorded on the balance sheet as liabilities. Upon delivery of goods and services, the prepayment received is recognized as income on the income statement.
Unearned Income Definition
Deferred or unearned income is the revenue that the company will receive in the future based on contracts and other documents. The balance sheet reflects subsidies, technical support funds, and other similar income under the Unearned Income line. Thus, the unearned income definition is straightforward.
Types of Unearned Income
Earned income depends on our direct efforts. First of all, this is the wages of employees. If an entrepreneur takes an active part in the work of his company, then his income can also be called labor.
Unearned income – those that went without labor costs. These include, for example, interest payments on deposits, dividends on securities, rent for an apartment, inheritance, lottery winnings, and social benefits.
Benefits of Unearned Income
The principle of compliance that governs accounting states that revenues must be consistent with the expenses that were used to generate these revenues. Sometimes, an enterprise receives assets, that is, income that is not specifically related to the current accounting period because the expense is allocated for a longer time.
Theoretically, the funds could have been received over a long period, but they were all received at once. In such situations, accountants prefer to report profits in the amount not exceeding the income of the current period and put the funds received that are not related to it on sub-accounts – unearned income.
Unearned Income Examples
For example, the organization rents out real estate. It was paid rent for three years at once. The asset is there. If you write it all in this year’s income, the amount of the tax base of the income tax will be increased. If only the payment for the current year is taken into account as profit, then the remaining funds should be taken into account as unearned income. They will be reflected in the profit balance in the next two years, thus proportionally distributing the tax base. This situation corresponds to the current unearned income tax filing requirements.
Other unearned income examples include:
- Rent. The lease agreement may provide for payment in advance for a certain time. Deferred or unearned income can also be recognized as a deposit that is paid at the beginning of the lease but is set off for its last month.
- Advance payments are funds transferred under the contract for goods or services that have not yet been provided to the buyer for subsequent settlements. They will be recognized as unearned income if the advance is made for more than one accounting period in advance.
- Sponsored “gifts”. Gratuitous receipts provided for by the gift agreement were long attributed to the period of receipt, and tax was also recorded and paid on this profit.
But if you consider this asset as a long-term asset that will “work” for the firm for several years, then it can quite legitimately be considered as a deferred profit. This can be attributed to received grants.