Prepayments are expenses paid in advance and the unexpired up is accounted as current assets in the Balance Sheet.
Vice versa, revenues received in advance are payment received from customers for work not yet done or goods to be delivered at some future date.
So how do we treat revenues received in advance?
Revenues received in advance:
Are money (cash or cheque) received in advance.
They are actually liabilities to the business as the business has still not earned the revenue because goods or services have still not been provided to the customers.
The portion that goods have been delivered or services being provided during the accounting period are treated as incomes in the Income Statement whilst those not earned yet are treated as a current liability which is called prepaid revenues, deferred revenues and unearned revenues
Examples are: deferred maintenance fees, unearned fee from advertising services/
Illustration of Accounting Treatment of Revenue Earned In Advance:
Assuming Company A which is a publishing house received a cheque of $1,200 being 12 monthly issue of a magazine starting from 1 st June 2005. [ this means that the $1,200 is meant for the period from 1 st June 2005 to 31 st May 2006. The entity’s accounting period ends at 31 st December.
There are two(2) ways of accounting treatment:
(1) To record the receipt of this money INITIALLY as revenue in the Income Statement:
Credit: Subscription Revenue $1,200
Being initial receipt of subscription revenue earned in advance.
Next, at the end of the accounting period namely 31/12/2005, to take up the relevant portion that the company has NOT yet earned specifically from 1 st January 2005 to 31 st May 2006 [5 months x $100 which is $500]
Debit: Subscription Revenue $500
Credit: Unearned subscription revenue (Balance sheet) $500
Being transfer of the portion of unearned income to balance sheet.
(2) The second method is to initially record the whole $1,200 as Unearned subscription revenue as current liability in the Balance Sheet.
Debit: Bank $1,200
Credit: Unearned subscription revenue (Balance sheet) $1,200
Being initial take up of 100% of subscription money into balance sheet item.
Next, at the end of the accounting period, transfer from the unearned subscription revenue (balance sheet) the portion of EARNED portion as income in the Income Statement.
Debit : Unearned subscription revenue (Balance Sheet) $700
Credit : Subscription Revenue (Income Statement) $700
Being recognition of the portion of unearned subscription revenue as income.
At the end of the day, using either above-mentioned methods, only the earned portion which is $700( 1 st June to 31 st December 2005) being correctly taken up as income in the Income Statement leaving behind the balance of unearned portion of $500 as current liability (unearned subscription revenue account) in the Balance Sheet.
Revenues received in advance are RECOGNIZED AS INCOME IN THE INCOME STATATEMENT for only the portion of goods delivered or services/work-done being rendered. This is based on the PRUDENCE OR CONSERVATISM Concept.
Based on this concept, ONLY the ascertained portion is taken up as revenue/income, the balance of goods not delivered or work not yet done is taken up in the Balance Sheet. Only when work being done or goods actually being delivered, can they be matched and taken up into the Income Statement