Before You Start

This guide is for accrual-basis accounting. A basic understanding of debits and credits is recommended.

Overview

20 min
Setup Time
Advanced
Difficulty
Monthly
Adjustments

What You’ll Learn

  • How to correctly classify customer payments as unearned revenue
  • Creating the necessary liability accounts in your accounting system
  • Journal entries for recording initial retainers and monthly recognition
  • Compliance with ASC 606 principles for revenue recognition

1. The Accrual Principle: Unearned Revenue

Under accrual accounting, revenue is recognized when earned, not when cash is received. Payments received for services or goods not yet delivered are called unearned revenue.

Key Characteristics

  • Payment received in advance.
  • Obligation to deliver goods/services in the future.
  • Initially recorded as a liability on the balance sheet.

Examples

  • Monthly retainer for consulting services.
  • Annual software subscription paid upfront.
  • Gift cards sold (until redeemed).

2. Setting Up Your Chart of Accounts

You’ll need a specific liability account to track unearned revenue.

Unearned Revenue Account Details

  • Account Name: Unearned Revenue or Customer Deposits
  • Account Type: Other Current Liability
  • Normal Balance: Credit
  • Purpose: To hold funds received from customers until earned.

3. Journal Entry: Initial Retainer Payment

When you receive a retainer or deposit, the cash increases, but your revenue does not. Instead, a liability is created.

Example: $5,000 retainer received from Client A on January 1st.

Journal Entry Details

DEBIT
  • Cash (Bank Account) ⬆️ $5,000
CREDIT
  • Unearned Revenue (Other Current Liability) ⬆️ $5,000

4. Journal Entry: Recognizing Revenue (Monthly Adjustment)

As you perform services or deliver goods, a portion of the unearned revenue becomes earned. This requires a monthly adjusting entry.

Example: Recognize $1,000 of the $5,000 retainer on January 31st after delivering services.

Journal Entry Details

DEBIT
  • Unearned Revenue (Other Current Liability) ⬇️ $1,000
CREDIT
  • Service Revenue (Income) ⬆️ $1,000

5. Accounting for Refunds or Project Completion

  1. 1

    Scenario 1: Project Completed

    If the project finishes and all revenue is earned, the Unearned Revenue balance for that client should be zero after all adjusting entries are made.

  2. 2

    Scenario 2: Partial Refund

    If a client cancels and you refund unearned funds, you will Debit Unearned Revenue and Credit Cash for the refund amount.

  3. 3

    Scenario 3: Forfeited Deposit

    If a deposit is forfeited (becomes fully earned without services rendered, as per your contract), perform the normal revenue recognition entry to move it from Unearned Revenue to Service Revenue.

ASC 606 & Revenue Recognition

For public companies or those following GAAP strictly, ASC 606 (Revenue from Contracts with Customers) provides detailed guidance. Key principle: recognize revenue when performance obligations are satisfied.

6. Common Pitfalls to Avoid

Avoid These Mistakes

  • Recording retainers directly as income upon receipt.
  • Forgetting to make monthly adjusting entries to recognize earned revenue.
  • Not tracking unearned revenue per client, making reconciliation difficult.
  • Ignoring sales tax implications on deposits (if applicable in your jurisdiction).

Need Help?

Expert Accounting Advice

Unsure about your specific retainer agreement or need help structuring your chart of accounts? Our certified experts are here to assist.

Contact Us