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 December 31?
Solution Of Multiple Choice Question (MCQ)
Correct Answer: D. $9,000
Understanding unearned revenue is a common challenge in accounting exams and multiple-choice questions. The key is to determine how much of the payment has been earned by the end of the accounting period and how much still represents an obligation to provide future services.
Step 1: Understand the Scenario
- Contract value: $12,000
- Contract start date: October 1
- Contract length: 12 months
- Payment: Received in full on October 1
- Accounting method: Accrual accounting
- Reporting date: December 31
Since the company receives the entire payment upfront, it cannot recognize all $12,000 as revenue immediately. Under the accrual method, revenue is recognized only as the company provides the agreed-upon services.
Step 2: Calculate Monthly Revenue
The contract covers 12 months.
Monthly revenue = $12,000 ÷ 12 = $1,000 per month
From October 1 through December 31, the company has completed 3 months of service.
Revenue earned = 3 × $1,000 = $3,000
Step 3: Calculate Unearned Revenue
The remaining nine months of services have not yet been provided.
Unearned Revenue = $12,000 − $3,000 = $9,000
Therefore, the amount reported as Unearned Revenue on December 31 is $9,000.
Correct Answer: D. $9,000
Why Is $9,000 Considered Unearned Revenue?
Unearned revenue is a liability because the company has received payment but still owes services to the customer.
As of December 31:
- Services provided: 3 months
- Revenue recognized: $3,000
- Services still owed: 9 months
- Unearned Revenue: $9,000
This $9,000 remains on the balance sheet as a liability until the company performs the remaining services over the next nine months.
Adjusting Journal Entry on December 31
At the end of the accounting period, the company recognizes the portion of revenue that has been earned.
| Account | Debit | Credit |
|---|---|---|
| Unearned Revenue | $3,000 | |
| Revenue | $3,000 |
Explanation: This adjusting entry transfers the revenue earned during October, November, and December from the liability account (Unearned Revenue) to the Revenue account.
Final Answer
- Total payment received: $12,000
- Revenue earned by December 31: $3,000
- Unearned Revenue remaining: $9,000
Correct MCQ Answer: D. $9,000
Key Takeaway
When solving accrual accounting questions, always remember:
- Cash received does not automatically become revenue.
- Revenue is recognized only as services are performed.
- The remaining amount is recorded as Unearned Revenue, which is reported as a current or long-term liability depending on when the services will be provided.
By following these three steps, you can confidently solve similar unearned revenue MCQs in accounting exams and interviews.
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