Why Is Unearned Revenue Considered a Liability?

Unearned revenue is a liability in a company's balance sheet because the firm has not yet completed a contract, nor has the company fully delivered goods or services in return for prepayment, according to AccountingTools. The company gradually adds revenue to its balance sheet until the contract is done.

Examples of unearned revenue include a lease agreement, a service contract, prepaid insurance and a legal retainer. All of these types of services are paid in advance, notes AccountingTools. For instance, Company A pays Company B $10,000 in November for plowing services related to an upcoming winter. Company B has unearned income, listed as a liability, until the five-month contract for plowing snow off Company A's parking lot is completed in March. Every month, Company B takes $2,000 of the $10,000 unearned income liability and makes it revenue. At the end of March, all $10,000 becomes revenue at the completion of the service contract.

Companies that receive unearned, or prepaid, income have a legal obligation to fulfill the contract terms. Extra prepaid income may be used to invest in other areas of a company or to purchase more inventory, explains Investopedia. However, a company that does not deliver the prepaid goods or services may be held liable in court if the contract is not fulfilled.