What type of account is created when cash is collected in advance of service delivery?

When cash is collected in advance of service delivery, it creates a liability account. This situation arises because the company has received payment for a service that it has not yet provided. Thus, there is an obligation to deliver that service in the future.

The advance payment represents a liability because the company owes the customer the service that they have already paid for. Until the service is performed, the payment cannot be recognized as revenue; it remains a liability on the balance sheet. The appropriate entry would be to debit the cash account (increasing an asset) and credit a liability account, commonly referred to as "Unearned Revenue" or "Deferred Revenue."

Once the service is rendered, the liability decreases, and revenue can then be recognized, thus reflecting the company’s fulfillment of its obligation. This accounting treatment aligns with the accrual basis of accounting, which recognizes revenues when they are earned and expenses when they are incurred, rather than when cash is received or paid.

Conducting this correctly ensures compliance with accounting principles and provides a true representation of the company’s financial obligations and performance.