Typically, deferred revenue is listed as a “current” liability on the balance sheet due to prepayment terms ordinarily lasting fewer than twelve months. On August 31, the company would record revenue of $100 on the income statement. On the balance sheet, cash would be unaffected, and the deferred revenue liability would be reduced by $100.

In some cases, companies may be required to pay taxes on the revenue received even though it has not yet been earned. By properly accounting for deferred revenue, companies can ensure that they are paying the correct amount of taxes based on their actual earnings. Although it’s a liability, having a deferred revenue balance on your books isn’t necessarily a bad thing. For example, if a business pays out a performance bonus deferred revenues definition annually and one of their employees has been smashing goals every month, the bonuses are adding up. With each month, a business can record the performance bonuses as a liability on their balance sheet to accurately record what they’ll need to pay out at the end of the period. To illustrate deferred revenue, let’s assume that a company designs websites and has been asked to provide a price quote for a new website.

What is Deferred Revenue?

In other words, the revenue or sale is finally recognized and the money earned is no longer a liability. Deferred revenue is often mixed with accrued expenses since both share some characteristics. For example, both are shown on a business’s balance sheet as current liabilities.

This is because there is still a chance that the seller may not provide the goods or service or that the buyer will cancel the transaction. A customer may pay for an annual subscription in advance, but the company will initially recognize the paid amount as deferred revenue. The service provider will recognize only the subscription it has delivered as revenue. The remainder of the deferred revenue will remain in the balance sheet, and the company will reduce the balance every month as it delivers the subscription.

Why is deferred revenue considered a liability?

Deferred revenue is popular among software and insurance companies, which often demand upfront payments in exchange for long-term service terms. The same applies when you order magazines or make a reservation, money is paid before the service is provided. Different business models may have different methods for recognizing deferred revenue. It’s important to understand your business model and how deferred revenue is recognized under that model. Assume a company received a payment of $5,000 in advance for services to be rendered over the next six months.

Your bookkeeping team imports bank statements, categorizes transactions, and prepares financial statements every month. Since you haven’t delivered on all 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. These rules can get complicated—and to top it off, the Financial Accounting Standards Board (FASB) recently overhauled them. For a detailed rundown of how to recognize revenue under the new GAAP rules, check out our guide to revenue recognition.

TaxCloud (Direct Tax Software)

Therefore, under accrual accounting, if customers pay for products or services in advance, you cannot record any revenue on your income statement. A balance sheet liability account that reports amounts received in advance of being earned. For example, if a company receives $10,000 today to perform services in the next accounting period, the $10,000 is unearned in this accounting period. It is deferred to the next accounting period by crediting a liability account such as Unearned Revenues.

• If a customer pays for goods/services in advance, the company does not record any revenue on its income statement and instead records a liability on its balance sheet.
• The timing of recognizing revenue and recording is not always straightforward.
• Some industries also have strict rules around what you’re able to do with deferred revenue.
• An example of unearned revenue could be a magazine publisher that offers annual subscriptions.
• As such, companies should be prepared to manage their cash flow accordingly.

Each contract can stipulate different terms, whereby it’s possible that no revenue can be recorded until all of the services or products have been delivered. In other words, the payments collected from the customer would remain in deferred revenue until the customer has received what was due according to the contract. Under the revenue recognition principles of accrual accounting, revenue can only be recorded as earned in a period when all goods and services have been performed or delivered.

Deferred revenue in SaaS

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. For example, a contractor might use either the percentage-of-completion method or the completed contract method to recognize revenue.

As the expenses are incurred the asset is decreased and the expense is recorded on the income statement. Deferred revenue is recorded as a liability on the balance sheet, and the balance sheet’s cash (asset) account is increased by the amount received. Once the income is earned, the liability account is reduced, and the income statement’s revenue account is increased.

Deferred Revenue: Definition, Examples, and Best Practices

Sometimes businesses take an advance payment on a good or service meaning they’ve been paid upfront and now they need to fulfill their end of the deal. For instance, if a business buys tech supplies from another company but still has not received an invoice for the purchase, it records the accrued expense into the balance sheet. The same goes for employees’ salaries and bonuses accrued in the period they take place but paid in the following period. However, if the business model requires customers to make payments in advance for several years, the portion to be delivered beyond the initial twelve months is categorized as a “non-current” liability.