What is Deferred Revenue and Why is it a Liability? Bench Accounting

This distinction differentiates deferred revenue that the company expects to earn in less than a year and in more than a year. Deferred revenue is money received in advance for products or services that are going to be performed in the future. Rent payments received in advance or annual subscription payments received at the beginning of the year are common examples of deferred revenue. Deferred revenuerefers to money you receive in advance for products you will supply or services you will perform in the future. For example, annual subscription payments you receive at the beginning of the year or rent payments you receive in advance. This deferred revenue definition implies a lag between purchase and delivery.

The company that receives the prepayment records the amount as deferred revenue, a liability, on itsbalance sheet. There is nodifference between unearned revenue and deferred revenuebecause they both refer to advance payments a business receives for its products or services it’s yet to deliver or perform. Thus, they are items on a balance sheet you initially enter as a liability but later become an asset. Deferred revenue on Apple’s 2018 balance sheet.Upon delivery, deferred revenue becomes earned revenue on a company’s income statement. The money received from a client may be claimed as earned revenue in full after completion or in parts over a certain period of time.

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Deferred Revenue (or “unearned” revenue) is created when a company receives cash payment in advance for goods or services not yet delivered to the customer. Deferred revenue is a liability on a company’s balance sheet that represents a prepayment by its customers for goods or services that have yet to be delivered. It’s also good practice to generate cash flow statements https://online-accounting.net/ to best understand how deferred revenue affects cash going in and out of your business. When you receive the payment, it will need to be recorded in the deferred revenue account since you have yet to provide the services for which your client has paid. A deferred revenue register lists income that has been promised or received but is not yet recognized as earned.

This entry reduces the deferred revenue by the monthly fee of $1,250 while recognizing the revenue for January in the appropriate revenue account. This journal entry will need to be repeated for the next five months until the entire amount of deferred revenue has been properly recognized. 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. You can enter them into the P & L by spreading the Cost impact over several Periods during which they are deemed to have occurred. This allows for the proper accounting of an advance lump sum Billing to a Customer and the smoothing of the consequent revenues over future periods.

Why Recognize Deferred Revenue?

Now you know a bit more about deferred revenue, but what type of account is deferred revenue? Well, in general, assets are things that have value, and revenue is the money received from selling goods or services.

In other words, AR is credited when revenue is earned but not received, and as money is realized AR is debited and cash balance credited. While deferred revenue is classified as a liability, accounts receivable is an asset on the balance sheet until payment is actually received. Under accrual accounting, financial transactions are recorded as and when they occur. This means that when you create a deferred revenue journal entry, you only log revenue for what has been delivered. If, for example, a customer pays $1000 in advance for two months of service, and you’ve only delivered one month, only $500 would be recorded as revenue. In accrual accounting, you only recognize revenue when you earn it, unlike in cash accounting, where you only earn revenue when you receive a payment period.

How to Adjust an Entry for Unearned Revenue

And we Credit Revenue to reflect that the Good or Service has been delivered and that the transaction is now earned and substantially complete. However, the Companyowes delivery of the goods or services to the Customer in the future.

As the expenses are incurred the asset is decreased and the expense is recorded on the income statement. Since deferred revenues are not considered revenue until they are earned, they are not reported on the income statement. As the income is earned, the liability is decreased and recognized as income. While cash from deferred revenues might sit in your bank account just like cash from earned revenues, the two are not the same. If you don’t deliver the agreed-upon good or service, or your customer is unhappy with the end product, your deferred revenues could be at risk. Generally speaking, you should be more careful spending cash from deferred revenues than regular cash. Besides being a requirement of the matching principle of accrual accounting, recognizing deferred revenues is a good business practice because it prevents over-valuing your business.

Why is deferred revenue treated as a liability?

Recording the entire $10,000 in the month it’s received will result in an overstatement of net income for that month, with a subsequent understatement of income for the following months. What Kind of Account Is Deferred Revenue? Deferred Revenue reflects an obligation to deliver goods or services to a Customer in the future. Deferred Revenue is created when a customer prepays for a future good or service.

They represent the amount of money that is owed to another person or company. For example, accounts payable, loans and mortgages are common liabilities. A similar term you might see under liabilities on a company’s balance sheet is accrued expenses. Generally, deferred revenue refers to unearned money – that is, payments for goods or services to be delivered in the future. Usually, you record this revenue as a liability until you have made the delivery .

When a legal practice charges a new client a $10,000 retainer fee, it isn’t immediately recorded as revenue in its books. It records it as deferred revenue first, and only records $10,000 in revenue after the entire retainer fee has been earned. Once the customer receives the chairs, they will pay you the $2,500 balance, which again will be recorded in deferred revenue until the next 50 chairs are completed and shipped. At that time, the balance in deferred revenue will be recognized and recorded as sales revenue.

• Deferred revenue is expected among SaaS companies because they offer subscription-based products and services requiring pre-payments.
• The Period Number selected in the Report filters determines which and how many of these Postings will appear in the chosen Report.
• Consequently, the revenue amount booked during the defined period will be “taken out” from the deferred revenue account.
• As the product or service is delivered over time, it is recognized as revenue on the income statement.

This can cause you to think you’ve grown and start investing the unrecognized balance to keep the growth momentum. This misleads your investors to believe that you’re growing when the reality is something different.