What Deferred Revenue Is in Accounting, and Why It’s a Liability
The initial receipt of deferred revenue is straightforward since you’ve received revenue you have not earned yet. Determining when the revenue has been earned can be trickier and should be done with caution. In this example, the company would record the following journal entries for deferred revenue.
Companies must know their deferred revenue balance and properly account for it in their financial statements. This is crucial for accurately representing the company’s financial health and performance. Understanding the distinction between deferred revenue and revenue is essential for businesses to manage their cash flow and make informed business decisions effectively. In other words, accrual accounting focuses on the timing of the work that a business does to earn revenue, rather than focusing on the timing of payment. From a tax perspective, deferred revenue allows businesses to defer revenue recognition on their income statement until the goods or services are delivered. This can have significant tax implications, as it may result in lower taxable income in the current period.
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The amount customers pay you in advance for your cleaning subscription is the deferred revenue. As you perform your cleaning services, parts of the deferred revenue become earned revenue. So, if you clean for a client once per week, the amount of money equal to the weekly service becomes earned revenue after you perform the service each week. A golf club charges its members SAR 120 in annual dues, which are levied right away when a member registers to join the club.
When accountants talk about «revenue recognition,» they’re talking about when and how deferred revenue gets turned into earned revenue. A similar term you might see under liabilities on a company’s balance sheet is accrued expenses. Whereas deferred revenue is money that a business has received but hasn’t provided the good or services for, accrued deferred revenue is classified as expenses are incurred when a business has received the good or service, but hasn’t paid the money. Deferred revenue represents money received from customers for goods or services that haven’t yet been delivered. As straightforward as it might sound, managing this financial element poses several risks that businesses must be aware of.
By Business Model
In total, the company collects the entire $1,000 in cash, but only $850 is recognized as revenue on the income statement. Accrued revenue is income earned by a company that the company has not yet been paid for. Therefore, the company opens a receivable balance as it expects to get paid in the future. While the company got cash upfront for a job not yet done when considering deferred revenue, the company is still waiting for cash for a job it has done. The payment is considered a liability because there is still the possibility that the good or service may not be delivered or the buyer might cancel the order.
In a business combination, the acquiring entity (the acquirer) recognizes deferred revenue of the acquired company (acquiree) if it relates to 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. Deferred revenue is an accounting concept that provides a snapshot of a business’s financial health and operational agility. In subscription-based or prepayment business models, deferred revenue is an especially informative metric for stakeholders ranging from CFOs to investors.
