What is unearned revenue and how is it adjusted?

• A. Unearned revenue is revenue earned in advance; adjust by recognizing revenue.
• B. Unearned revenue is a revenue item recognized when cash is received.
• C. Unearned revenue is a liability representing cash received before performance; adjust by recognizing revenue (Debit Unearned Revenue; Credit Revenue).
• D. Unearned revenue is an asset that becomes revenue automatically.

Answer: (C)

Unearned revenue is the liability created when a company receives cash before it has performed the promised service or delivered the goods. The adjustment moves that amount from a liability to actual revenue once the performance obligation is satisfied: Debit Unearned Revenue; Credit Revenue. This shows that the obligation is fulfilled and revenue is now earned.

For example, if you receive $5,000 in advance for a service to be provided later, you would record cash and unearned revenue. When you later perform part or all of the service, you reduce the liability and recognize revenue by debiting unearned revenue and crediting revenue for the amount earned.

The other statements mix up timing or misclassify the accounts: revenue is not recognized simply because cash is received in advance, and unearned revenue is not an asset.