Is Deferred Service Revenue a Debit or Credit?
Is deferred service revenue debit or credit? Any time a company or individual receives payment for future services, this is called unearned service revenue. It might also be recorded as deferred service revenue. Unearned revenue is the money that a business receives in advance for a good or service. In regard to this, unearned service revenue is more specific to services paid in advance and is usually common among service-oriented businesses.
A business can only record revenue in the income statement when it has been earned. Therefore, if a business receives payment in advance, then the revenue is classified as unearned service revenue and carried as a liability on the balance sheet until the business has carried out the services. The unearned service revenue journal entry is the tracking mechanism for this type of revenue, during the business’s bookkeeping. Now, the question is, how is this type of revenue recorded?; is unearned service revenue a debit or credit in the T-account?
In this article, we will discuss unearned service revenue, debit, credit, and the correct journal entry for this type of revenue.
Related: Is service revenue a permanent account?
Understanding deferred service revenue
Deferred service revenue (or Unearned service revenue) is the income that an individual or business has received for services that have not yet been rendered. This kind of revenue is usually received in advance of the services being rendered, and as such, it is treated not as revenue but as a liability on the company’s balance sheet.
This is because revenue under accrual-based accounting is only recognized when it is earned. Hence, it is a liability account that shows the business’s obligation to its customer. It is only when the business delivers the goods or services, that the journal entry for this prepayment becomes real revenue.
Therefore, unearned service revenue or any other kind of unearned revenue is recorded as a liability until the services are performed. Once the services that were paid for have been performed, the unearned service revenue is then recognized on the business’s income statement as revenue.
Unearned service revenue can arise from prepayments for services, subscription-based services, legal retainers, airline services, or membership fees. This kind of revenue is important for businesses because it gives a source of income that can be used to generate profits and cover expenses. Unearned revenue is common for service businesses, but there are some other unearned revenue examples that are not service-based such as advance rental payment, deposits for large orders of goods, prepaid insurance, etc.
Now that we have an understanding of unearned service revenue; is unearned service revenue debit or credit? Let’s discuss debit and credit in double-entry bookkeeping to understand the correct journal entry for unearned service revenue.
Debit and credit (double-entry bookkeeping)
The debit and credit entry is used in Pacioli‘s double-entry accounting system to record transactions within a business’s chart of accounts. In accounting, when recording a transaction, the debit entry must have a corresponding credit entry that equals the same amount.
It is important to note that an asset and expense account will increase by a debit entry and will reduce by a credit entry. Whereas, revenue, equity, and liability accounts will increase by a credit entry and decrease by a debit entry. Since unearned service revenue which is our main focus is treated as a liability, it means, it will increase by a credit entry and decrease by a debit entry. Does this mean unearned service revenue is not a debit but a credit entry? Let’s discuss this further.
See also: Service Revenue Asset or Liability?
Is unearned service revenue debit or credit?
Therefore, the initial entry of unearned service revenue should be a debit to the cash or bank account and a credit to the unearned service revenue account. This journal entry will show that the business has an influx of cash but the cash has been earned on credit. The journal entry for this would be as follows:
Debit and credit journal entry for unearned service revenue
| ACCOUNT | DEBIT | CREDIT |
|---|---|---|
| Cash or Bank account | 00 | |
| Unearned Service Revenue | 00 |
Later on, as the individual or business actually provides the services to the client, an adjusting journal entry will be made. As the services are provided, the revenue is earned, thereby reducing the balance in the unearned service revenue account with a debit entry and then increasing the balance in the Service revenue account with a credit entry.
This means that the unearned service revenue account will be debited and the Service revenue account will be credited by the same amount. The journal entry for unearned revenue that has been earned would therefore be as follows:
Debit and credit journal entry for unearned service revenue that has been earned
| ACCOUNT | DEBIT | CREDIT |
|---|---|---|
| Unearned Service Revenue | 00 | |
| Service Revenue | 00 |
In conclusion, as seen in the initial journal entry for unearned service revenue, the unearned service revenue account would be credited while the cash or bank account would be debited. Hence, unearned service revenue is not a debit but a credit. This journal entry is the same for other kinds of unearned revenue; that is all unearned revenue should have a normal credit balance. The bottom line is unearned service revenue will increase with a credit entry and decrease with a debit entry.
Related: Drawings Debit or Credit?
Unearned service revenue debit and credit journal entries examples
Recording unearned service revenue means creating a debit to your assets and credit to your liabilities. As this unearned service revenue is recognized as revenue, it debits the unearned service revenue account and credits the service revenue on your income statement. In order to explain this, let’s look at an example:
Assuming ABX business provides equipment maintenance services and bills customers $6,000 annually in advance. When ABX business issues this invoice, and the customers pay, no maintenance cover has been provided. This means that the revenue of $6,000 is an unearned service revenue and a journal entry is required. The journal entry below shows the bookkeeping entries for the maintenance services that were paid for in advance:
Debit and credit journal entry for unearned service revenue for maintenance services
| ACCOUNT | DEBIT | CREDIT |
|---|---|---|
| Bank account | $6,000 | |
| Unearned Service Revenue account | $6,000 |
As soon as the maintenance services are provided, the unearned service revenue will be recognized as revenue. As mentioned earlier, the maintenance contract costs $6,000 for one year. Let’s say ABX business produces monthly financial management accounts, each month $500 will become the recognized revenue and will be credited to the services revenue account in the income statement with the following journal entry:
Debit and credit journal entry for unearned service revenue recognized as revenue
| ACCOUNT | DEBIT | CREDIT |
|---|---|---|
| Unearned Service Revenue | $500 | |
| Service Revenue | $500 |
That is, at the end of the 12 months all the unearned service revenue (unearned) will have been taken to the service revenue account (earned).
Related: Sales return debit or credit?
