What Does Deferred Revenue Mean?
Deferred revenue is money that a company receives in advance for products and services. Simply put, these products and services will, at a later date, be delivered or performed. Deferred revenue hasn’t been earned yet and represents deliverables owed to a customer.
Deferred income, deferred revenue, customer deposits, and unearned revenue are often used interchangeably.
How Does Deferred Revenue Work?
Since deferred revenue is technically an advance payment from a customer, the company is obligated to deliver products or services as promised. If the customer cancels the order or the company is unable to keep its promise of delivering goods/services, the company will need to refund the money (unless other terms were explicitly agreed upon in a signed contract).
Since contracts may have varying terms, it’s possible that a company won’t record any revenue until all products and services have been delivered in full. Once a company fulfills its part of the agreement, the deferred revenue is recognized as “earned revenue” on the income statement.
For each contract or sale, a company needs to make a deferred revenue journal entry. This information will include when the cash received is debited to the cash account and when the deferred revenue account is credited.
Common Deferred Income Examples
Some of the most common deferred revenues include:
Rent payments received in advance
Annual subscription payments
Pre-sale for products (such as for a new launch)
Deposit for repair or maintenance work
Prepaid insurance premiums
Is Deferred Income an Asset or a Liability?
On a company’s balance sheet, deferred revenue is a liability because it represents an obligation to a customer (i.e. the customer has prepaid for goods and services).
It isn’t considered as income because there’s still a chance that the customer may cancel the contract/order, or the company may be unable to deliver. Therefore, it’s treated as a liability because if the company can’t deliver, it will owe the customer money.
Once the goods or services are delivered, they’ll be recognized as revenue (since the company has fulfilled its obligation).
Where Is Deferred Income on the Balance Sheet?
Deferred revenue is listed as a liability on the balance sheet. You may find the title of the general liability account under deferred revenues, unearned revenues, deferred income, or customer deposits.
Once a company earns the amount by delivering a product or service, it can be moved to the income statement as revenue.
Deferred Revenue vs. Accounts Receivable
Accounts receivable represents money owed to the company by its customers for goods or services that have been sold and delivered – but not yet paid for. It is money that customers owe the company. Since the goods or services have been delivered, the company has earned revenue and can record that amount as revenue.
Deferred Revenue Example
Let’s say a software developer, Company ABC offers annual plans for their subscription social media automation service. Each subscription is $600 a year/$50 per month. When each payment is received, the company records that amount as a debit entry to the cash account and a credit entry to its deferred revenue account.
Each month, Company ABC continues to grant access to their automation service and recognizes it as revenue as the service has been delivered. The accounting department will record a $50 debit entry to the deferred revenue account and a credit entry to the revenue account for the same amount every month. At the end of the fiscal year, the entire balance of $600 will be “moved” to revenue on the income statement.
