Determining the value of operating activities for a business’s cash flow statement is an important part of preparing the disclosures a business needs to make to its investors. Many might think that unearned revenue would complicate the process of preparing the cash flow statement, since the money is in the bank, obviously affecting “cash flow,” but is not yet earned. Unearned revenue does not directly affect the cash flow statement, but as a current liability the fluctuation of its balance from year to year will influence the value of the operating activities on the financial statements.
Unearned Revenue
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Unearned revenue is cash received by a business for goods or services yet to be provided. It is recorded as a liability on the business’s balance sheet until the contract is completed. Unearned revenue can be accrued in a variety of different ways. For example, a one-year gym membership. When this right is purchased, the gym would get the cash for a year of service it has yet to provide. So when the cash is originally received, it will be recorded as unearned revenue. As each month passes a portion of that unearned revenue will be reclassified as “earned,” given that the service, a month of gym usage, will be provided. Unearned revenue that will be earned within the year and thus “pay off” the liability, is a current liability.
Operating Activities
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Operating activities, in terms of financial reporting, relates to a section of the cash flow statement. The cash flow statement is one of the four standard statements provided by businesses when they report their financial data to investors and debtors. Since most businesses report on an accrual basis, which focuses on when revenue is earned and expenses are generated as opposed to when cash is received or paid, this statement is important for showing a business’s liquidity. The operating activities section of the cash flow statement focuses on how cash is spent and received in relation to the business’s trade. Cash generated or spent on long-term investments or capital improvements are excluded from this calculation.
Operating Activities vs. Unearned Revenue
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Unearned revenue affects the calculation of the cash flow section of operating activities indirectly. The operating income portion of the cash flow statement is comparative; the focus is how much an account increased or decreased from last year. As a result, the net cash flow from operations equals net income plus depreciation expense, plus losses from sale of assets, minus gains from sale of assets, minus increases in current asset, plus decreases in current assets, plus increases in current assets, minus decreases in current assets. As unearned revenue is a current liability, the increase or decrease of unearned revenue from the prior year will affect the value of operating activities as it will appear on a business’s financial statements.
Considerations
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When preparing financial statements, consult with a certified public accountant to ensure that everything is done according to the appropriate accounting guidelines. This article does not provide legal advice; it is for educational purposes only. Use of this article does not create any attorney-client relationships.
