Which statement best describes the effect of unearned revenue on financial statements?

• A. It is a current liability; as revenue is earned, it decreases the liability and revenue increases.
• B. It increases revenue immediately and increases revenue again.
• C. It increases assets.
• D. It reduces cash and increases revenue.

Answer: (A)

When cash is received in advance for goods or services, the company records unearned revenue, a current liability that represents an obligation to deliver in the future. Revenue is not recognized at receipt; it’s recognized as the obligation is satisfied. As performance occurs, the liability decreases and revenue is recognized, increasing net income. This is why the statement that unearned revenue is a current liability and, as it’s earned, it decreases the liability and increases revenue is the best description. The other options misstate the timing or nature of the accounts: revenue is not recognized immediately upon receipt, unearned revenue itself is not an asset, and cash is not reduced while simultaneously increasing revenue.