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 December31?
The Correct Answer and Explanation is :
The unearned revenue as of December 31 can be calculated by recognizing how much of the $12,000 has not yet been earned by the company by the end of the year.
Step-by-Step Calculation:
- Total amount paid for the contract: $12,000
- The client paid the full $12,000 on October 1 for a contract that lasts for a year (from October 1 to September 30 of the following year).
- Revenue recognition under the accrual method:
- Under the accrual accounting method, revenue is recognized as it is earned, regardless of when cash is received.
- The contract covers a full year, so the revenue must be earned evenly over 12 months.
- Revenue earned by December 31:
- The period from October 1 to December 31 is 3 months.
- The monthly revenue earned is $12,000 / 12 months = $1,000 per month.
- For the three months from October 1 to December 31, the company would have earned 3 months × $1,000 = $3,000.
- Unearned revenue:
- Unearned revenue is the portion of the payment that has been received but not yet earned.
- Since $3,000 has been earned by December 31, the remaining unearned revenue is $12,000 (total payment) – $3,000 (earned revenue) = $9,000.
Explanation:
In accrual accounting, revenue is recognized as it is earned over time. For a one-year contract, the company is obligated to provide services or deliver goods over the entire year. Even though the company received the full $12,000 upfront, it can only recognize a portion of the payment as earned revenue each month.
By December 31, three months of the contract have been completed, so the company has earned $3,000. The remaining $9,000 represents the unearned revenue, as the company has yet to fulfill the remaining 9 months of the contract. This unearned revenue will remain on the balance sheet as a liability until the company has provided the contracted services or goods in the following months.