What is Deferred Revenue? Learn How it Works

Deferred revenue is a popular concept among both businesses and customers. In all the scenarios stated above, the company must repay the customer for the prepayment. With Patriot’s small business accounting software, you can quickly add entries and view reports. To help you understand deferred revenue, here’s a deferred income example.

Even if you don’t have any deferred revenue on your books, consider whether any of the income your business is earning now is paying for something you owe customers in the future. Some industries also have strict rules around what you’re able to do with deferred revenue. For example, most lawyers are required to deposit unearned fees into an arms-length IOLTA trust account. The penalties for removing unearned cash from an IOLTA account can be harsh—sometimes even leading to disbarment. As a small business owner, being paid in advance for goods and services can provide a needed boost to cash flow.

What is Deferred Revenue for SaaS?

In other words, the payments collected from the customer would remain in deferred revenue until the customer has received in full what was due according to the contract. Also known as deferred income or unearned revenue, deferred revenue needs to be recorded differently than accrued revenue or accounts receivable. The opposite of deferred revenue is accrued revenue (i.e., revenue recognized before cash is received). The deferred revenue account is normally classified as a current liability on the balance sheet. It can be classified as a long-term liability if performance is not expected within the next 12 months. Deferred revenue is a payment from a customer for future goods or services.

When you receive the money, you will debit it to your cash account because the amount of cash your business has increased. And, you will credit your deferred revenue account because the amount of deferred revenue is increasing. Technically, you cannot consider deferred revenues as revenue until you earn them—you deliver the products or services prepaid. Over time, when the product or service is delivered, the deferred revenue account is debited and the money is credited to revenue.

It prevents you from overvaluing your business

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. Operating liabilities are amounts owed resulting from a company’s normal operations, whereas non-operating liabilities are amounts owed for things not related to a company’s operations. Deferred revenue is revenue recorded for services or goods that are part of its operations; therefore, deferred revenue is an operating liability.

• A company incurs deferred revenue by following through on its end of the contract after payment has been made.
• Businesses that provide subscription-based services routinely have to record deferred revenue.
• For example, you sign a 12-month, $12,000 contract with a customer and you invoice the full amount upfront.
• Bench assumes no liability for actions taken in reliance upon the information contained herein.
• The deferred revenue account is normally classified as a current liability on the balance sheet.

It is also important to know that this unearned cash should not be invested in your future projects until it’s earned. A conservative approach to calculating revenue will present a more realistic picture of your company’s growth. If you’re using the wrong credit or debit card, it could be costing you serious money.

Which Accounting Tool to Choose For Deferred Revenue?

Paired with your Customer Lifetime Value (CLV) and your Customer Acquisition Cost (CAC), it’ll give you good insights into your business performance. It’s also helpful to compute your ARR and MRR – you can use your monthly deferred revenue being recognized as a starting point. Since you haven’t delivered on all definition and different types of income tax the website support throughout the year yet, you should classify the support fee separately in your contract, and only recognize that revenue as you earn it. Because the membership entitles Sam to 12 months of gym use, you decide to recognize $200 of the deferred revenue every month—$2,400 divided by 12.

Deferred revenue is earned when a company collects money for a service it has yet to provide. This usually happens for service companies that wait to perform the job until at least a portion of the job is paid for. A company incurs deferred revenue by following through on its end of the contract after payment has been made. You’re thinking “A liability? Shouldn’t it be an asset, especially if I already got paid upfront?” Nope. And accrual accounting (the exchange of cash) is largely disconnected from your revenue recognition.

When in doubt, please consult your lawyer tax, or compliance professional for counsel. Sage makes no representations or warranties of any kind, express or implied, about the completeness or accuracy of this article and related content. Performance obligations are explicitly stated in your contract and may include something not stated but common in your business processes. This makes it important to know and track stated promises your business practices. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

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. Deferred revenue is typically a good thing as long as you’re able to deliver the goods and services that you owe your customers. Unlike other liabilities, deferred revenue that keeps on growing is a positive sign for your business. Increasing deferred revenue means that your business is collecting advanced payments from clients. In accrual accounting, unearned revenue cannot be recognized until a critical event has occurred, like a product being sold or a service performed, and a quantifiable amount of money has been exchanged.

Why Companies Record Deferred Revenue

With a subscription business model, it can be tricky to know when that is. As with any business model or industry, there’s naturally some risk involved. However, this doesn’t make deferred revenue riskier to manage than regular revenue.

Understanding the basics of accounting is vital to any business’s success. Under the accrual basis of accounting, recording deferred revenues and expenses can help match income and expenses to when they are earned or incurred. This helps business owners more accurately evaluate the income statement and understand the profitability of an accounting period.

At this date, since the subscription service hasn’t been rendered yet, the revenue is $0, and the deferred revenue is $1.200. Unearned revenue is the opposite of unbilled revenue (or accrued revenue), which is revenue that has been earned but has not been invoiced yet to your client. Bench gives you a dedicated bookkeeper supported by a team of knowledgeable small business experts. We’re here to take the guesswork out of running your own business—for good. Your bookkeeping team imports bank statements, categorizes transactions, and prepares financial statements every month.

If you’re using the cash accounting method, there’s no need to worry about revenue recognition since revenue is only recognized when cash is received. It reconciles your deferred revenue account balance on your balance sheet and provides a forecast of your expected revenue stream in the future. Unless your Professional Services Firm strictly contracts on time and materials, you may need to account for deferred revenue.

Overview: What is deferred revenue?

When closing the books for January, your accountant will be creating your monthly financial statements. At that time, the accountant will debit the deferred revenue of $549 from your credited revenue. When you receive the payment, it will need to be recorded in the deferred revenue account since you have yet to provide the services for which your client has paid. Although it’s more common for service businesses, other types of businesses also need to account for deferred revenue.

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 either case, the company would repay the customer, unless other payment terms were explicitly stated in a signed contract. For example, you sign a 12-month, $12,000 contract with a customer and you invoice the full amount upfront. You should typically recognize pieces of revenue over time as you perform the service. RevRec identifies the performance obligations of each contract and recognizes revenue automatically when it is paid.