You’ve received payment from a customer, but you’re not delivering the goods or services paid for until next month.
How should you account for that in your financial records?
You record the transaction as deferred revenue.
In this guide, we’ll explain what deferred revenue is, how it impacts financial statements, and best practices for using and managing deferred revenue.
What is deferred revenue?
Deferred revenue is money your business receives in advance for goods or services that you haven’t yet delivered or performed.
It’s kind of like the opposite of accounts receivable, which is a payment owed to your company by a customer for work completed or goods delivered.
Accounts receivable is an asset, since it is cash your business expects to receive. Naturally, deferred revenue is recorded as a liability on the balance sheet, then, as it represents an obligation to provide goods or services in the future.
Both are important components of accrual accounting.
Deferred revenue vs. unearned revenue
Deferred revenue is often called unearned revenue. These are interchangeable terms. Both refer to revenue you’ve received but not yet earned.
Examples of deferred revenue in different industries
To give you a better idea of how deferred revenue works in practice, here are a few examples in different industries:
- SaaS and software: When a customer pays for a 12-month subscription upfront, the company recognizes that revenue monthly as the service is delivered. Until then, it is recorded as deferred revenue.
- E-commerce and retail: When a customer buys a gift card, but the store hasn’t yet provided the goods, that revenue is deferred until the card is redeemed.
- Airlines and travel: When a passenger books a flight several months in advance, the airline may record this as deferred revenue and only recognize it as received revenue once the flight takes place.
How deferred revenue affects financial statements
Deferred revenue has an impact on all three of the key financial statements:
- Balance sheet
- Income statement
- Cash flow statement
Balance sheet
Deferred revenue is recorded as a current liability if the revenue is expected to be earned within a year, or as a long-term liability if the obligation extends beyond a year.
Income statement
Deferred revenue is not recognized as revenue when it is received, as the company has not yet earned it.
Once that company fulfills its obligation, the deferred revenue moves from the liability section of the balance sheet to be recognized as revenue on the income statement.
Cash flow statement
Since the cash is received upfront, it appears as an inflow in the operating activities section of the cash flow statement.
It doesn’t impact net income on the income statement, however, since it isn’t yet earned.
Why record deferred revenue?
Recording deferred revenue is essential for keeping accurate financial records as well as for maintaining compliance with account standards such as GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards).
Recording deferred revenue helps us to:
- Ensure accurate revenue recognition
- Align with the matching principle
- Avoid creating misleading financial statements
- Improve cash flow management
- Maintain compliance with regulatory requirements
- Reflect business model sustainability
Accounting for deferred revenue
Which accounting principles are involved?
The use of deferred revenue in accounts is guided by GAAP and IFRS, drawing on two core principles:
- Revenue recognition principle. Revenue should only be recognized when earned, not when cash is received.
- Matching principle. Expenses incurred to deliver a product or services should be matched with the period in which the revenue is recognized.
Methods of recognizing and recording deferred revenue
When a customer prepays, the company initially records the payment as a liability (deferred revenue).
The Cash (Asset) account receives a debit entry, and the Deferred Revenue (Liability) account receives a credit entry for the same amount.
As the company delivers the service or product, the revenue is recognized by reducing the deferred revenue liability. This can happen instantly or gradually, depending on the nature of the transaction.
For example, if the customer purchases goods in advance, and those goods are delivered all in one go, then there will be one journal entry.
If, however, the prepayment is for something like a subscription, then the revenue may be gradually recognized monthly (e.g. $1,000 per month for an initial upfront $12,000 annual payment).
In this case, the Deferred Revenue (Liability) account is debited and Revenue (Income Statement) is credited.
The impact of deferred revenue on cash flow
When deferred revenue is received, it appears as a cash inflow under the operating activities section of the cash flow statement.
There is no additional cash impact as the revenue is recognized over time since the cash was already received.
This means that, from a cash flow perspective, there is no difference between deferred revenue and revenue that is immediately recognized.
Deferred revenue vs accrued revenue
Deferred revenue and accrued revenue are used in conjunction to reflect financial actualities.
Here’s a quick overview of the differences:
So, how do you determine whether to enter a sale as deferred or accrued revenue?
The best way is to consider the timing of cash flow.
If the cash has already been received but the revenue hasn’t yet been earned, then it's Deferred Revenue. If the revenue has been earned but the cash hasn’t been received yet, then it's Accrued Revenue.
Implications for financial reporting & analysis
The use of deferred and accrued revenue has some important implications for financial reporting and analysis.
Revenue recognition & profitability
Deferred revenue delays recognition. That means that revenue isn’t immediately reflected in your company’s net income, even if you’ve already received the cash.
Accrued revenue accelerates recognition. It increases revenue and profit, even though the cash hasn’t been collected yet.
Cash flow analysis
While deferred revenue boosts cash flow now, it does create future obligations.
Accrued revenue, on the other hand, reflects expected income. However, if a customer is late to pay, it can strain cash flow.
Financial ratios & investor analysis
Investors look at your company’s deferred and accrued revenue balances to understand its financial operations. For instance, they’ll look at operating cash flow to assess how well that revenue translates into actual cash earned.
A high deferred revenue balance indicates strong pre-sales, but it also indicates future obligations.
A high accrued revenue balance, however, suggests that there is some collection risk to be considered.
How to record deferred revenue
Here’s how to correctly record deferred revenue.
1. Initial payment received
When you receive cash before delivering the goods or services, you’ll record the amount received as a liability (deferred revenue).
Let’s say, for example, that a SaaS company receives a $12,000 upfront payment for an annual subscription.
Their ledger entries would look like this:
- Debit Cash - $12,000
- Credit Deferred Revenue - $12,000
2. Recognizing revenue over time
As the company delivers the service, the deferred revenue is gradually recognized in the income statement.
Each month, the following ledger entries take place:
- Debit Deferred Revenue - $1,000
- Credit Revenue - $1,000
3. Completion of revenue recognition
By the end of the full 12-month period, the full deferred revenue balance has been recognized as revenue and transferred to the income statement.
Best practices for managing deferred revenue
Looking to get on top of deferred revenue?
Here are a few best practices that financial leaders should follow:
- Align revenue recognition with contract terms and service delivery to avoid premature or delayed recognition of revenue
- Use a straight-line or milestone recognition methods to improve revenue recognition consistency
- Regularly reconcile deferred revenue accounts
- Maintain clear audit trails and records of customer contracts, invoices, and revenue recognition schedules
- Ensure that contracts with deferred revenue components are tracked, especially for subscription-based models
Software solutions for automating deferred revenue tracking
Many software solutions exist to help you track and monitor deferred revenue automatically.
These include subscription management solutions like Chargebee and Zuora as well as bookkeeping and accounting platforms like Xero and QuickBooks, both of which integrate smoothly with BILL to open up a powerful world of reporting and analysis capabilities.
Compliance considerations and reporting requirements
While the use of deferred revenue helps you stay compliant with GAAP and IFRS guidelines, when entering transactions as deferred revenue, it's important to ensure you’re also compliant with reporting requirements.
These differ depending on your state and country, but generally speaking:
- Companies must disclose their deferred revenue policies and revenue recognition timing in financial statements
- Deferred revenue transactions should be well-documented and readily available for auditing
- It is a best practice to have internal controls in place to prevent revenue misstatements
It's also important to be aware that tax reporting requirements may differ from accounting treatment. Some jurisdictions allow deferring on taxable income, while others will require you to recognize income upon cash receipt. Consult your accountant to ensure compliance.
Spot trends and discover opportunities with BILL
Understanding what deferred revenue is and how to use it is an important step in improving financial knowledge and gaining control over business profitability.
While you’re on the path toward greater financial ownership, you’ll need a capable technological guide to help you extract insights from data and take action.
BILL, our financial operations platform, is packed with powerful features like:
- Cash flow forecasting
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