Legal Definitions - prepaid income

Prepaid income refers to money or payments a business receives from customers for goods or services that will be delivered or performed in the future. From an accounting perspective, this money is initially recorded as a liability because the business has an obligation to provide the promised goods or services. It only becomes recognized as actual income (or revenue) once the business fulfills its part of the agreement.

Here are some examples to illustrate prepaid income:

• Example 1: Annual Magazine Subscription

  Imagine a publishing company that sells a one-year subscription to its monthly magazine for $60. A customer pays the full $60 upfront in January. The publishing company has received the entire payment, but it has only delivered one issue of the magazine. The remaining $55 (for the 11 future issues) is considered prepaid income. As each subsequent magazine issue is delivered throughout the year, a portion of that $55 will be recognized as earned income, reducing the prepaid income liability.

• Example 2: Advance Payment for a Future Event

  A concert venue sells tickets in May for a major music festival scheduled to take place in August. Thousands of attendees purchase their tickets months in advance. The venue collects all the ticket revenue immediately. However, since the festival itself (the service of providing the entertainment and access to the event) has not yet occurred, all the money collected from these advance ticket sales is classified as prepaid income. It will only be recognized as earned revenue once the festival actually takes place in August.

• Example 3: Software-as-a-Service (SaaS) Annual Plan

  A company offers a cloud-based project management software and a client opts for an annual subscription plan, paying $1,200 upfront for 12 months of service. The software company receives the full $1,200 at the beginning of the year. For the first month, $100 is recognized as earned income. The remaining $1,100, representing the service to be provided over the next 11 months, is recorded as prepaid income. Each month, as the service is continuously provided, another $100 will be moved from prepaid income to earned revenue.