Accounting systematically divides arbitrary points in time into artificial time periods in order to assess the financial and economic conditions of an entity (Time Period Assumption). It is this division that allows a company to create periodic and annual financial statements and derive conclusions from them. As a result of this, certain transactions undertaken by a company must relate to the time period to which they correspond. In accounting this is referred to as the accrual basis of accounting. Accrual accounting mandates that companies record transactions that change a company’s financial statements in the period in which the events or transactions undertaken occur.
Prepaid expenses defer the recognition of expenses. Prepaid expenses are expenses that are paid for in advance by an entity. Because the future benefits that a company will receive from this type of transaction have not yet materialized, these advanced payments are recorded as assets. To record a prepaid expense, debit an asset account for the amount paid and credit cash.
Unearned revenues arise from prepayments to a company from customers or clients (consumers). Although, a company may have received cash, they have not performed any services or sold any goods, and, as a result may not recognize any revenue. Thus, these type of transactions defer revenue until a company has earned the right to claim it. When a company receives a prepayment, a liability account titled unearned revenue is credited.