what is an unearned discount 
an unearned discount is an interest or a fee that has been collected on a loan by a lending institution but has not yet been counted as income or earnings instead it is initially recorded as a liability as the life of the loan progresses proportionate parts of the fee or interest collected up front are removed from the liability side of the balance sheet and counted as income if the loan is paid off early the unearned interest portion must be returned to the borrower an unearned discount is more commonly referred to as unearned interest understanding unearned discountsan unearned discount account recognizes interest deductions before being classified as income earned throughout the term of the outstanding debt over time then the unearned discount creates an increase in the lender s profit and a subsequent decrease in liability not all interest that is received by a lender is classified as earned this is because lenders often pre schedule regular payments to be made at the beginning of each month but the interest paid by the borrower at the beginning of the month applies to the cost of borrowing for the entire month and therefore has not been earned by the lender for example say that a homeowner obtains a mortgage that requires them to make a monthly payment on the 1st of each month in the amount of 1 500 with 500 representing the interest portion however this 500 in interest is meant to cover the entirety of the month and it s considered to be unearned on the 1st as it is prepaid as the month progresses a pro rata amount of that interest is credited to the bank s earnings while the liability of the unearned discount is made smaller calculating an unearned discountunearned discounts may be estimated under the so called rule of 78 which is a method used for loans with precomputed finance charges if the loan is repaid or early or refinanced the rule of 78 can determine the unearned discount to the lender this works as follows 