Question #3: On March 1st, a customer paid your lemonade stand $3,000 cash in advance for 3 months of lemonade delivery service, performed for the customer at a rate of $1,000 per month, with the service starting to be provided on March 1st.
What adjusting entry should you make prior to preparing financial statements on April 30th?
So far, your lemonade stand has made only the following two entries related to this advance payment:
- The March 1st entry to record the receipt of the $3,000 cash.
- The March 31st adjusting entry.
Answer
| Transaction | Debit | Credit |
|---|---|---|
| Unearned Revenue | 1000 | |
| Service Revenue | 1000 |
Explanation
As your lemonade stand performs the services each month, it can record the amount performed for that month as revenue (specifically the Service Revenue account) and take the amount out of Unearned Revenue since they no longer have that liability.
So, after the second month’s performance of the services at the end of April, your lemonade stand will decrease the Unearned Revenue account. Since that account is a liability, we'll decrease it with a debit.
| Transaction | Debit | Credit |
|---|---|---|
| Unearned Revenue | ??? | |
| ??? | ??? |
By how much will we debit it?
Remember, you were initially paid $3,000 to cover 3 months of services. Therefore, each month we'll decrease Unearned Revenue by $1,000.
| Transaction | Debit | Credit |
|---|---|---|
| Unearned Revenue | 1000 | |
| ??? | ??? |
For every debit, there must be a credit. What account are we going to credit here?
The Service Revenue account! Essentially what this says is: "Hey, we finally did a month's work of lemonade delivery service on that lump sum payment we received! Now that we've done it, record it!"
Since we're essentially increasing revenue here, we must credit the Service Revenue account.
| Transaction | Debit | Credit |
|---|---|---|
| Unearned Revenue | 1000 | |
| Service Revenue | ??? |
By how much? The same amount of $1,000, since that's the month's worth of work performed in April!
| Transaction | Debit | Credit |
|---|---|---|
| Unearned Revenue | 1000 | |
| Service Revenue | 1000 |