What is the journal entry for receiving a pre-paid payment from a customer?

When a business receives a pre-paid payment from a customer, it is essentially collecting cash for goods or services that will be delivered or rendered in the future. The correct journal entry reflects this transaction accurately by recording the cash received and recognizing the obligation to deliver goods or services later.

The entry begins with a debit to Cash, which increases the cash account on the balance sheet. This step is essential as it acknowledges the inflow of cash into the business. Concurrently, the business must recognize that this cash is not yet revenue; instead, it creates a liability since the company has an obligation to provide the product or service in the future. Therefore, Unearned Revenue, representing that obligation, is credited. By crediting Unearned Revenue, the liability account increases, indicating that the company owes services or goods to the customer.

This approach reflects the accrual accounting principle, which states that revenue must be recognized when it is earned, not necessarily when cash is received. The entry captures the essence of the transaction correctly by aligning the cash inflow with the future obligation.