In accounting parlance, there are two accounts that create confusion in the minds of accountants as both look similar. These are prepaid and unearned accounts. Though they are similar, there are differences between these two accounts that will be discussed in this article to remove all doubts regarding them.
Prepaid account
Prepaid accounts are services that are paid in advance. The best examples are prepaid mobile recharge where a customer pays in advance for the value of the card irrespective of usage. Such accounts, as they can be had with cash are available to all people irrespective of credit ratings of the customers as they pay up the value in advance. On the other hand, unearned accounts are those where cash is received even before the service has been provided. Even though money is received, it is not treated as revenue as there is an obligation to deliver the services in future. It is only when that services have been delivered that revenues is recognized. Till then it is categorized as unearned revenue.
Unearned account
When you make a small down payment to the seller of a property to enter into a contract, the seller gets unearned revenue through this initial deposit. This is deemed as unearned revenue until the transaction has been completed and ownership transferred in your name. Similarly when you buy an air ticket and pay in advance for a travel later, the company has unearned revenue till you take your flight and thus the carrier provides its service. Another example is annual subscriptions of magazines where you pay for 12 months in advance and the owner has unearned revenues till he has delivered the final magazine of the contract period.
Prepaid and unearned accounts pose a challenge to accountants as it is possible for actual payment and delivery of services or goods to take place in different financial years. In such case, and to avoid violating book keeping rules, accountants make two initial entries to record the first transaction event and then later make two adjusting entries to record the second and final transaction event. Wherever there are prepaid accounts and unearned accounts, accrual accounting method is used and not cash basis accounting as it can create confusion.
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In brief: Prepaid vs Unearned Account • Prepaid accounts and unearned accounts are very common these days but present challenges to those involved in book keeping. • The best example of prepaid accounts is a prepaid mobile recharge where you pay in advance whereas unearned account is when a property seller accepts an initial deposit from the buyer in advance.
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