Deferred revenue: Is it a liability & how to account for it?

Often, you can deal with deferred revenue – something most SaaS subscription companies are familiar with. Deferred and unearned revenue are different words for the same important accounting concept. The second journal entry reflects the reduction in deferred revenue and the recording of September rent revenue. If a product or service cannot be delivered, you may have to offer your customers a refund, which can be difficult if cash has already been used to cover other expenses. Deferred revenue is important for any business, even small businesses with limited financial activity. Let’s say your cleaning business receives a $10,000 prepayment from one of its customers to pay for the entire year up front. In addition to the services mentioned above, any deposit collected from a customer in advance should be considered deferred revenue and recorded as such.

Although it’s a liability, having a deferred revenue balance on your books isn’t necessarily a bad thing. Sometimes businesses take an advance payment on a good or service meaning they’ve been paid upfront and now they need to fulfill their end of the deal. In some cases, the business needs to reflect this in their accounting. For accounts receivable, the only remaining step is the collection of cash payments by the company once the customer fulfills their end of the transaction — hence, the classification of A/R as a current asset. Therefore, if a company collects payments for products or services not actually delivered, the payment received cannot yet be counted as revenue. You will record deferred revenue on your business balance sheet as a liability, not an asset.

Prevents business over-valuation

This deferred revenue definition implies a lag between purchase and delivery. Understanding the basics of accounting is vital to any business’s success. Under the accrual basis of accounting, recording deferred revenues and expenses can help match income and expenses to when they are earned or incurred. This helps business owners more accurately evaluate the income statement and understand the profitability of an accounting period. Below we dive into defining deferred revenue vs deferred expenses and how to account for both. Deferred revenue is recognized as a liability on the balance sheet of a company that receives an advance payment.

Let us look at a detailed example of the accounting entries a company makes when deferred revenue is created and then reversed or earned. Deferred revenue is also known as prepaid revenue or unearned revenue. The payment is considered a liability because there is still the possibility that the good or service may not be delivered or the buyer might cancel the order. In either case, the company would repay the customer, unless other payment terms were explicitly stated in a signed contract. Due to its short-term nature, deferred revenue is often expected to satisfy within the next year. In all three situations, the company has performed business activity. Deferred revenue is revenue received for services or goods to be delivered in the future.

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Manufacturing businesses often accept deposits for large orders in advance of delivery. Until the products are delivered, the deposit should be recorded as deferred revenue.

• Since deferred revenues are not considered revenue until they are earned, they are not reported on the income statement.
• The pattern of recognizing $100 in revenue would repeat each month until the end of 12 months, when total revenue recognized over the period is $1,200, retained earnings are $1,200, and cash is $1,200.
• You’re probably paying several bills, or for services, using advanced payment already.
• This method will continue as you recognize $549 every month from your deferred revenue balance until it reaches 0.
• The timing of customers’ payments tends to be unpredictable and volatile, so it’s prudent to ignore the timing of cash payments and only recognize revenue when you earn it.

There is no difference between deferred revenue and unearned revenue, as both indicate the same thing — revenue that has been received for goods and services that have not yet been provided. Although it’s more common for service businesses, other types of businesses also need to account for deferred revenue.

Why is deferred revenue important?

For prepayments on product sales, the journal entries are similar. For example, one of your customers https://www.bookstime.com/ orders 100 chairs from you at a cost of $50 per chair, for a total cost of $5,000.

They’re available to you by message or appointment to go over your books and review key information. These rules can get complicated—and to top it off, the Financial Accounting Standards Board recently overhauled them. For a detailed rundown of how to recognize revenue under the new GAAP rules, check out our guide to revenue recognition.

Deferred revenue is recorded as a short-term liability on a company’s balance sheet. 12The amount realized typically includes cash received plus liabilities ­assumed. Recurring issues in fulfilling delivery could generate an unfavorable reputation for your business too. Ineffective revenue planning and management can jeopardize growth opportunities as well. To scale effectively with this revenue method you need to be able to successfully plan around delivery and mitigate any barriers to success. It’s important that you have an effective accounting tool to effectively monitor and recognize revenue. Operating ActivitiesOperating activities generate the majority of the company’s cash flows since they are directly linked to the company’s core business activities such as sales, distribution, and production.

Knowing when to recognize revenue is one reason why we have Generally Accepted Accounting Principles , which include detailed rules around revenue recognition that are tailored to each business type and industry. Here, we’ll go over what exactly deferred revenue is, why it’s a liability, and how you can record it on your books. FASB defines definitive guidance on the revenue recognition for contract delivering companies. ASC 606 provides the latest revenue recognition guidance for such companies. It is also important to know that this unearned cash should not be invested in your future projects until it’s earned. A conservative approach to calculating revenue will present a more realistic picture of your company’s growth.