On October 1, a client pays a company the full $12,000 balance of a year-long contract

On October 1, a client pays a company the full $12,000 balance of a year-long contract. Using the accrual method, what’s the unearned revenue as of December 31? $0 $1,000 $5,000 $9,000 $12,000

The correct answer and explanation is :

The correct answer is \$9,000.

Explanation:

In this scenario, the company receives a full payment of \$12,000 on October 1 for a one-year contract. Since the company is using the accrual method of accounting, revenue is recognized when earned, rather than when payment is received. This means that, although the company receives the entire payment upfront, the revenue must be recognized over the contract term (12 months in this case).

Let’s break this down:

1. Contract Details:

• The total contract amount is \$12,000 for one year.
• The payment is received on October 1.

1. Recognizing Revenue:

• Under the accrual method, the company recognizes revenue over time as the service is provided.
• The contract lasts 12 months, from October 1 to September 30.

1. Revenue per Month:

• The monthly revenue is calculated as: $$
  \frac{\$12,000}{12} = \$1,000 \text{ per month}
  $$

1. Earned Revenue by December 31:

• By December 31, the company has earned revenue for three months (October, November, and December).
• Therefore, the recognized revenue for these three months is: $$
  3 \text{ months} \times \$1,000 = \$3,000
  $$

1. Unearned Revenue:

• The payment received on October 1 covers the entire 12 months. However, by December 31, only 3 months of service have been provided, so the remaining 9 months of revenue is still unearned.
• The unearned revenue as of December 31 is the balance of the contract for the remaining 9 months: $$
  9 \text{ months} \times \$1,000 = \$9,000
  $$

Thus, the unearned revenue as of December 31 is \$9,000. This unearned revenue will be recognized as income in the following months as the service is provided.