What Is Deferred Revenue?
Deferred revenue is money that a company receives in advance for products and services. This means that 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 revenue requires a company to take some form of action before the money received can be considered revenue. If a company is unable to keep its promise of delivering services or goods, then it needs to refund the deferred or unearned income.
The terms 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 the customer, the company is obligated to deliver products or services as promised. If the customer cancels the order, the company needs to return the money (unless there are other terms 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, a company needs to make a deferred revenue journal entry, when the cash received is debited to the cash account and the deferred revenue account is credited.
Is Deferred Revenue an Asset or Liability?
Deferred revenue is a liability on a company’s balance sheet because it represents an obligation to a customer. In other words, the customer has prepaid for goods and services. It doesn’t count as income because there’s still a chance that the customer may cancel the contract or order, or the company may be unable to deliver. Therefore, it’s a liability because the company owes the goods or services to the customer. 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 Revenue on the Balance Sheet?
You’ll find deferred revenue on the balance sheet as a liability. You may find that the title of the general liability account can be found 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 counted as revenue. It’ll then 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.
Common Deferred Revenue
Some 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
Deferred Revenue Example
Let’s say a software company offers annual plans for their subscription social media automation service. Each subscription is $600 a year, or $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 the deferred revenue account.
Each month, the software company 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 fiscal year, the entire balance of $600 will have been “moved” to revenue on the income statement.