On October 1, a client pays a company the full $12,000 balance of a year-long contract. Using the accrual method, what’s the unearned revenue as of December 31
The Correct Answer and Explanation is :
Under the accrual accounting method, revenue is recognized when it is earned, regardless of when cash is received. The company received the full payment of $12,000 for a one-year contract on October 1. To determine the unearned revenue as of December 31, we need to understand that the payment covers the full 12-month period, but the revenue will be recognized over the duration of the contract.
Step 1: Determine the amount of revenue earned by December 31
The total contract is worth $12,000 for 12 months. Therefore, the monthly revenue from the contract is:
[
\frac{\$12,000}{12} = \$1,000 \text{ per month}
]
Since the contract started on October 1, the company will recognize revenue for the months of October, November, and December.
[
3 \text{ months} \times \$1,000 = \$3,000
]
Thus, by December 31, the company has earned $3,000 of the contract amount.
Step 2: Calculate the unearned revenue as of December 31
Unearned revenue represents the amount of money the company has received but not yet earned. Since $3,000 has been earned by December 31, the remaining $9,000 is unearned revenue. This is because the company has not yet provided the services for January through September.
[
\$12,000 – \$3,000 = \$9,000
]
Conclusion
As of December 31, the unearned revenue is $9,000. This amount represents the portion of the $12,000 that has been paid but not yet earned by the company because the service period continues into the next calendar year.
This distinction between earned and unearned revenue ensures that the company accurately reflects its financial performance, recognizing revenue only when it has been earned, not when the cash is received.