GreenLawn Co provides landscaping services to clients. On May 1, a customer paid GreenLawn $70,000 for 6 months services in advance. GreenLawn’s general journal entry to record this transaction will include a:
Debit to Unearned Revenue for $70,000.
Credit to Accounts Receivable for $70,000
Credit to Cash for $70,000
Credit to Unearned Revenue for $70,000
Debit to Accounts Receivable for $70,000
The correct answer and explanation is :
When GreenLawn Co receives $70,000 on May 1 for six months of landscaping services to be provided in the future, it has an obligation to deliver these services over the next six months. In accrual accounting, revenue is recognized when it is earned, not when cash is received. Therefore, the payment is initially recorded as unearned revenue, a liability representing GreenLawn’s obligation to perform the services.
The correct journal entry to record this transaction is:
- Debit Cash for $70,000, increasing the company’s cash balance.
- Credit Unearned Revenue for $70,000, recognizing the liability for services to be performed.
This entry reflects the receipt of cash and the corresponding obligation to provide services in the future.
As GreenLawn performs the services each month, it will recognize a portion of the unearned revenue as earned revenue. For example, each month, $11,666.67 ($70,000 ÷ 6 months) will be recognized as revenue. The adjusting journal entry at the end of each month would be:
- Debit Unearned Revenue for $11,666.67, reducing the liability.
- Credit Service Revenue for $11,666.67, recognizing the earned revenue.
This process continues until all services are rendered and the unearned revenue is fully recognized as earned revenue.