Deferred Revenue Understand Deferred Revenues in Accounting

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In addition, the receipt of advance payments is common in sectors like real estate and retail, creating deferred revenue until the products or services are delivered. This requires meticulous tracking on behalf of accounting teams to ensure accurate financial reporting that reflects all the complexities of deferred revenue management and the revenue recognition principle. When a company receives advance payment, it adds to its cash holdings and offsets that amount on its balance sheet with deferred revenue, or “unearned revenue,” until it delivers the product or service. At that point, it can remove the liability from the balance sheet and record the unearned revenue as revenue on its income statement. Deferred or unearned revenue represents payments received in advance for products or services yet to be delivered. Common in subscription-based models and prepaid services, it’s essential in financial accounting, ensuring that revenue is accurately reported.

You shouldn’t spend it the same way you spend regular cash

A company with deferred revenue should have more financial flexibility than a company needing to invest its own cash up front before offering its product to customers. The deferred expenditure is listed as an asset on the balance sheet of the business (e.g., prepaid rent). The cash account receives a credit for the same amount while that account is debited.

The timing of recognizing revenue and recording is not always straightforward. Accounting standards according to GAAP, or Generally Accepted Accounting Principles, allow for different methods of revenue recognition depending on the circumstances and the company’s industry. Deferred revenue is classified as a liability because the recipient has not yet earned the cash they received. The company must satisfy its debt to the customer before recognizing revenue. Due to its short-term nature, deferred revenue is often expected to satisfy within the next year.

Can You Have Deferred Revenue in Cash Basis Accounting?

Both are critical concepts in accrual accounting that dictate the timing of income recognition in conjunction with the FASB’s ASC 606 revenue recognition guide. Put another way, it signifies advanced payments received for goods and services that have yet to be delivered. It’s essential that this revenue is treated differently than recognized revenue (see below) since all the contractual promises have yet to be carried out, and the order could end up canceled (the revenue, therefore, refunded). Put simply, deferred revenue is income received for goods or services that haven’t yet been delivered or rendered. In this case, the payment is recorded upfront, which creates a liability until the obligation is fulfilled.

A country club collects annual dues from its customers totaling $240, which is charged immediately when a member signs up to join the club. In a business combination, the acquiring entity (the acquirer) recognizes deferred revenue of the acquired company (acquiree) if it relates to deferred revenue is classified as a legal performance obligation assumed by the acquirer. When a legal performance obligation is assumed, the acquirer may recognize a deferred revenue liability related to the performance obligation. In a business combination, the acquired deferred revenue liability must be valued.

Before Anything: What Is A Liability?

The club would recognize $20 in revenue by debiting the deferred revenue account and crediting the sales account. The golf club would continue to recognize $20 in revenue each month until the end of the year when the deferred revenue account balance would be zero. On the annual income statement, the full amount of $240 would be finally listed as revenue or sales.

This concept arises from the accrual basis of accounting, which requires companies to report revenue immediately when it’s earned and records expenses immediately when it’s incurred, regardless of the cash coming in or going out. With the roll-out of ASC 606, there was a slight adjustment to the terminology for deferred revenue, as well as accrued revenue. Now, if an agreement has deferred revenue, it is referred to as being in the “contract liability” position whereas accrued/unbilled revenue is now known as being in the “contract asset” position.

It’s also important to note that due to recent accounting standard changes, there will be some additional considerations related to deferred revenue valuation. Further articles in our deferred revenue valuation series will cover these topics in more detail. Since deferred revenue is a liability that is earned, it reduces the working capital of the company. Working capital is calculated as operating current assets less operating current liabilities. In this formula since operating current liabilities is deducted, it will lower the overall working capital requirement of the company.

This is because money is transferred from customers’ accounts into the business before the delivery of goods or services. On August 1, the company would record a revenue of $0 on the income statement. On the balance sheet, cash would increase by $1,200, and a liability called deferred revenue of $1,200 would be created. Deferred revenue is common in industries like software as a service (SaaS), media subscriptions, and membership services.