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If you have ever prepaid for goods or services from a company, the revenue that you paid is considered deferred revenue for that business. Deferred revenue is defined as money a business receives before it delivers a product or service.
Read on to learn more about deferred revenue’s meaning, what some common examples are, and how to handle it in your account books.
Key Points
• Deferred revenue means money a business receives before delivering the product or service the money is paying for, making it essentially payment that has not yet been earned.
• When it comes to accounting, deferred revenue is classified as a liability on the company’s balance sheet because it represents an obligation to deliver goods or services.
• Unearned revenue, another term for deferred revenue, differs from earned revenue, which refers to goods or services a company has already delivered to fulfill its obligation to the customer.
• A familiar deferred revenue example is a monthly magazine subscription, where subscribers pay for a full year up front.
• To record deferred revenue, debit the cash account and credit the deferred revenue account, then reduce the liability and recognize revenue on the income statement once the goods or services are delivered.
What Is Deferred Revenue?
Deferred revenue is essentially money you’ve received but haven’t earned yet.
For example, if someone pays for a year of services from your business up front, that money is not necessarily considered revenue since you still need to deliver on that service for the next year. Instead, the payment will be recorded on the books as deferred revenue. Once the service is delivered on time, it will be recognized as revenue on the books.
Deferred Revenue on the Balance Sheet
When you’re doing your small business accounting, it’s important to understand how to record deferred revenue. As mentioned above, this can be a bit involved.
When a company gets paid for a good or service that they haven’t delivered yet, the payment isn’t considered revenue right away. This payment goes into a deferred revenue account and is classified as a liability on the company’s balance sheet. It’s considered a liability because the company owes the customer a product or service at a future date.
Accrued expenses are essentially the opposite of deferred revenue – they represent goods or services a company has received but not yet paid for. These are also recorded as liabilities on the balance sheet.
Deferred Revenue vs Earned Revenue
Deferred revenue is also called unearned revenue because the payments are received before the goods or services are delivered, making it a liability. Earned revenue, in contrast, refers to goods or services that a company has delivered to fulfill its obligation to the customer. If the earned revenue was originally deferred revenue, the revenue would then move from the liability section of the balance sheet to the income statement. This indicates that the revenue is now actual income.
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Common Deferred Revenue Examples
One familiar example of deferred revenue is a monthly magazine subscription. Subscribers may pay for a full year of the magazine up front. Even though the company receives the whole amount of the yearly subscription in a lump sum, it’s not considered part of the company’s revenue immediately. Each month, as that month’s magazine is delivered, the company can move a portion of the subscription amount to indicate that it’s now revenue.
Another common deferred revenue example is software leasing. Software companies typically collect annual prepayments for software that will be used every month by the customer. Each month, the software company can transfer a 1/12 portion of the fee to its revenue.
How Deferred Revenue Works: Revenue Recognition
Deferred revenue starts out recorded as a liability on the balance sheet. As the company delivers the goods or services it was paid for, the amount will be transferred (often in increments, if relevant) to be listed as revenue on the income statement (another key business financial statement).
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Why Deferred Revenue Matters for Your Business
Even though it’s recorded as a liability, deferred revenue can provide companies with upfront cash and predictable income. The upfront cash can be used to fund operations, invest in growth, or manage short-term obligations without relying on small business loans or other funding.
The Takeaway
If your company offers goods or services for which prepayment is an option, you’ll probably be dealing with deferred revenue. It’s important to understand how to handle this in terms of your financial statements. It’s also key to know how to manage customer expectations. Customers who prepay expect a timely and seamless delivery of the goods or services they’ve paid for. It’s a good idea to ensure that your company can deliver on time and in full to meet or exceed customer expectations.
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FAQ
What is the difference between deferred revenue and accounts receivable?
Deferred revenue’s definition is money a company receives before it actually delivers goods or services, and it’s recorded as a liability until delivery actually takes place. Accounts receivable is money owed by customers for goods or services already delivered, and it’s recorded as an asset.
How is deferred revenue recorded in a journal entry?
To record deferred revenue, debit the cash account and credit the deferred revenue account. The debit to cash increases the cash account, reflecting the payment received. The credit to the deferred revenue increases the deferred revenue account, which is a liability. As the company delivers the goods or services on time, debiting deferred revenue decreases the liability as the obligation is fulfilled, while crediting revenue increases the revenue account, reflecting the earned income.
Is deferred revenue a liability or an asset?
Deferred revenue is a liability because it represents an obligation to deliver goods or services in the future.
What happens to deferred revenue when a service is delivered?
When the service is delivered, deferred revenue is reduced on the balance sheet and recognized as revenue on the income statement.
Can deferred revenue ever become a permanent liability?
Deferred revenue is not normally considered a permanent liability as it is a temporary obligation that will eventually be fulfilled. If the company fails to fulfill its obligation to provide the goods or services, the deferred revenue will become a refund liability.
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