In accounting, earned describes revenue for which a business has done what it promised to do: it has delivered the goods, performed the service or otherwise satisfied its obligation to the customer. Under the accrual basis of accounting, revenue is recorded when it is earned, not when the cash is received. Revenue that has been paid for in advance but not yet provided is described as unearned.
The idea is at the heart of the revenue recognition principle. Older US standards said revenue should be recognized when it was both earned and realized or realizable. The current standard on revenue from contracts with customers, issued by the FASB and effective for most companies from 2018, expresses the same idea in terms of satisfying performance obligations by transferring control of goods or services. "Earned" remains the everyday word accountants use for that moment.
Earned revenue in plain terms
A gardener who mows a lawn on Monday and sends the bill on Friday has earned the money on Monday, when the job was done. The customer still owes it, but the work is finished. On the other hand, if a customer pays the gardener in March for a whole summer of mowing, the gardener has not earned that money yet. It is earned bit by bit, each time a lawn is cut.
Accounting follows the work, not the cash. That way each month's income shows what the business actually did in that month, which gives a fairer picture than simply counting money as it comes in.
When revenue is earned
Under the five-step model in current US GAAP, a business identifies the contract, identifies its separate promises, determines the price, allocates the price to each promise, and recognizes revenue when, or as, each promise is satisfied. In practice this leads to two patterns:
- At a point in time. A retailer earns revenue when the customer takes control of the goods, usually at the till or on delivery.
- Over time. A consulting firm, a builder on a long contract or a software company selling a subscription earns revenue progressively as the service is performed.
The customer's ability to pay matters too: a contract exists for this purpose only if it is probable the business will collect the amount it expects to be entitled to.
Recording earned and unearned amounts
If revenue is earned before cash is received, the business records a receivable. A law firm that completes $8,000 of work in December and bills in January records, in December, a debit to Accounts Receivable (or accrued revenue if not yet billed) and a credit to Fees Earned for $8,000.
If cash comes first, the business records a liability. A publisher that sells a $120 annual subscription on January 1 debits Cash $120 and credits Unearned Revenue, a contract liability, for $120. Each month an adjusting entry moves $10 from Unearned Revenue to Subscription Revenue as the magazine is delivered. By year-end all $120 has been earned.
Earned, received and realized
The three words are often confused. Earned refers to performance; received refers to cash arriving; realized traditionally meant exchanged for cash or a claim to cash. A business can have earned revenue it has not received, as with sales on credit, and received cash it has not earned, as with customer deposits. Income accounts such as service revenues and interest earned show amounts earned in the period, whatever their cash status.
The counterpart on the cost side is an expense that has been incurred. Under the matching principle, expenses incurred to earn revenue are recognized in the same period as that revenue, so the income statement reflects the true result of each period's activity.
Cash basis and tax
Small businesses that keep their books on the cash basis record revenue when cash is received rather than when earned, which is simpler but can distort period results. For US federal income tax, many small businesses may use the cash method, while larger businesses and most with inventories generally use an accrual method, subject to rules that sometimes differ from financial reporting on the timing of advance payments.