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.
Unearned revenue arises when a company receives cash or other assets as payment from a customer before conveying (or even producing) the goods or performing the services which it has committed to the customer.
Unearned revenue is assumed to represent the obligation to the customer to refund the assets received in the case of nonperformance 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 grounds that the amount of unrealized profit is uncertain and usually not material relative to the total obligation.
Unearned revenues arise from the following activities:
(1) The sale by a transportation company of tickets or tokens that may be exchanged or used to pay for future fares.
(2) The sale by a restaurant of meal tickets that may be exchanged or used to pay for future meals.
(3) The sale of gift certificates by a retail store.
(4) The sale of season tickets to sports or entertainment events.
(5) The sale of subscriptions to magazines.
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