Unearned revenue: Definition, accounting and tips for managing small business cash flow

Published Wednesday 26 November 2025

Table of contents

• What is unearned revenue?
• Is unearned revenue an asset or liability?
• Unearned revenue vs other revenue types
• How to record unearned revenue
• Managing unearned revenue for better cash flow
• Start using Xero for free
• FAQs on unearned revenue

Key takeaways

• Record unearned revenue as a liability on your balance sheet when payment is received, then transfer it to revenue only after you deliver the goods or services to maintain accurate financial statements.

• Utilize unearned revenue to improve cash flow by receiving upfront payments that provide immediate working capital to cover expenses and reinvest in your business without taking on debt.

• Apply proper journal entries by debiting cash and crediting unearned revenue when payment is received, then reversing this by debiting unearned revenue and crediting revenue upon delivery completion.

• Implement accounting software like Xero to automatically track and manage unearned revenue transactions, ensuring compliance with Canadian accounting standards and simplifying the recording process.

What is unearned revenue?

Unearned revenue is money your customer pays you for goods or services you haven't yet delivered. Also called deferred revenue or unearned income, it's payment received before you've earned it.

This advance payment structure benefits your business in three key ways:

• Cash flow boost: Money comes in upfront so you can cover expenses or reinvest
• Cost management: Helps offset expensive production costs before delivery
• Payment security: Reduces risk of unpaid invoices since committed customers pay first

Proper recording keeps your tax records current and gives stakeholders a clear view of your financial position.

Unearned revenue examples

• Travel: People usually pay for airline tickets, hotel bookings and event tickets ahead of their travel.
• Accommodation: Renters often pay landlords weeks or months ahead.
• Subscription services: Providers of digital software, newspapers and online streaming services typically charge annual subscriptions.
• Contract services: Contractors and service providers like painters, copywriters and caterers may request payment before starting work.
• Professional services: Law firms, for example, may use unearned revenue by charging a retainer before they start work.
• Insurance: Insurance companies often use unearned revenue by charging premiums for a year. The policyholder pays for a year upfront and receives insurance cover throughout the year.
• Online shopping: Online retail companies charge fees for goods before the goods are shipped.

Is unearned revenue an asset or liability?

Unearned revenue is a liability.

Think of it as a promise you've made to a customer. You have their money, but you still owe them the product or service they paid for. Until you deliver, that money is a liability.

On your balance sheet, unearned revenue is listed under liabilities. This is because you have a duty to either deliver the goods or services, or return the money. Once you fulfil your end of the deal, the liability is removed, and the amount is recognized as earned revenue on your income statement.

Unearned revenue vs other revenue types

Unearned revenue affects your financial reporting differently from other revenue types. Here's how it compares:

• : Money clients owe for delivered goods or services
• : Accumulated profits kept in your business after expenses and taxes
• Prepaid expenses: Advance payments you've made for future goods or services
• Accrued revenue: Revenue you've earned but haven't been paid for yet

Understanding these differences helps you categorize transactions correctly in your books.

How to record unearned revenue

Proper tracking of unearned revenue keeps your financial statements current and compliant. While accounting software like Xero accounting software automates this process, understanding the basics helps you monitor your position.

Key requirements for Canadian businesses:

• Accounting Standards for Private Enterprises (ASPE) Section 3400: For many Canadian private enterprises, recent amendments to Section 3400 regarding upfront non-refundable fees have had their effective date deferred indefinitely as of May 2024.
• Accrual accounting: The Canada Revenue Agency (CRA) prefers this method.

records transactions when they occur, not when money changes hands.

For example, you record a December sale as December revenue, even if payment arrives in March.

Recording unearned revenue in your financial statements

Recording unearned revenue involves two main steps:

Step 1: Initial payment

Record the payment in your cash or bank account and create an unearned revenue liability account.

Step 2: Delivery completion

Move the amount from unearned revenue to your revenue account once you deliver.

Balance sheet treatment

Unearned revenue appears as a liability because you owe goods or services.

• Current liability: You expect to deliver within one year
• : You expect to deliver after more than one year

Only record revenue when you earn it in that period.

Journal entries

You record unearned revenue in two steps using double-entry bookkeeping:

Initial payment received:

• Debit: Cash account
• Credit: Unearned revenue account

After delivery completion:

• Debit: Unearned revenue account
• Credit: Revenue account

This two-step process helps you track payments and deliveries accurately.

Managing unearned revenue for better cash flow

Managing unearned revenue improves your cash flow and business planning.

Cash flow benefits:

• Upfront payment: Provides immediate working capital
• Predictable income: Helps plan expenses and investments
• Reduced risk: Less worry about future payment collection

For subscriptions or ongoing services, divide the total payment by the number of service months to see your monthly earning rate and what you still owe.

For instance, Canada's Accounting Standards Board (AcSB) has noted that some entities are incorrectly recognizing initiation fees up-front instead of deferring them.

FAQs on unearned revenue

You’ve seen the essentials of unearned revenue, but you might still have questions. Here are answers to some common queries.

Is unearned revenue credit or debit?

When you first receive the payment, you credit the unearned revenue account, which is a liability, and debit your cash account, which is an asset.

Do I pay taxes on unearned revenue immediately?

Generally, no. For tax purposes, revenue is typically recognized when earned. For instance, the Canada Revenue Agency (CRA) allows taxpayers who sell extended warranty plans to deduct a reasonable amount for the portion of the premium that relates to the period after the end of the year. So, you'll pay taxes on it after you've delivered the goods or services. It's always best to consult with an accountant for advice specific to your business.

What happens if I can't deliver the goods or services I was paid for?

If you can't fulfil the order, you'll typically need to refund the customer. The journal entry would be reversed: you'd debit the unearned revenue account and credit your cash account to show the money has been returned.

How long can revenue remain unearned?

Revenue stays unearned until you deliver the product or service. For tax purposes, you may deduct a reserve for goods sold where payment is not due for more than two years from the sale date. For a one-year subscription, it's recognized monthly over the year. For a custom project, it's recognized when the project is complete.