Understanding Deferred Revenue vs Accrued Expense
The pattern of recognizing $100 in revenue would repeat each month until the end of 12 months, when total revenue recognized over the period is $1,200, retained earnings are $1,200, and cash is $1,200. Earned revenue, on the other hand, is the revenue that has been earned through the sale of goods or services delivered or provided to customers. Here’s a practical illustration to better understand the concept of deferred or unearned revenue.
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. On August 1, Cloud Storage Co received a $1,200 payment for a one-year contract from a new client.
Identify transactions that involve the deferred revenue
So, even though this deferred revenue shows up in your business’s bank account, it can’t be counted as revenue just yet. It’s also important to note that in most cases, deferred revenue should be reported as a current liability, as prepayment terms tend to be for less than 12 months. In accrual accounting, you only recognize revenue when you earn it, unlike in cash accounting, where you only earn revenue when you receive a payment period.
Just because you have received deferred revenue in your bank account does not mean your clients will not ask for a refund in the future. Additionally, some industries have strict rules governing how to treat deferred revenue. For example, the legal profession requires lawyers to deposit unearned fees into an IOLTA trust account to satisfy their fiduciary and ethical duty. The penalties for non-compliance can be harsh—sometimes leading to disbarment.
Deferred revenue is expected among SaaS companies because they offer subscription-based products and services requiring pre-payments. Under the cash basis of accounting, deferred revenue and expenses are not recorded because income and expenses are recorded as the cash comes in or goes out. This makes the accounting easier, but isn’t so great for matching income and expenses. Learn more about choosing the accrual vs. cash basis method for income and expenses. Deferred revenue helps apply the universal principle in accrual accounting — matching concept.
- If a company incurs an expense in one period but will not pay the expense until the following period, the expense is recorded as a liability on the company’s balance sheet in the form of an accrued expense.
- Do not invest as-yet unearned money to maintain a balanced picture of your company’s position and growth potential.
- For example, a contractor might use either the percentage-of-completion method or the completed contract method to recognize revenue.
- When it comes to deferred revenue vs. accrued revenue, there couldn’t be any more differences, because they’re diametrically opposed to one another.
- In other words, deferred revenues are not yet revenues and therefore cannot yet be reported on the income statement.
Deferred expenses, much like deferred revenues, involve the transfer of cash for something to be realized in the future. Deferred revenues refer to money received for goods or services to be provided to customers later, whereas deferred expenses refer to money expended for obligations not yet observed. When any payments are received, the deferred revenue liability is recorded in the credit side of the company balance.
Accounting for Deferred Expenses
Deferred revenue is common with subscription-based products or services that require prepayments. Examples of unearned revenue are rent payments received in advance, prepayment received for newspaper subscriptions, annual prepayment received deferred revenues definition for the use of software, and prepaid insurance. In accounting, deferred revenue is incurred when customers make a payment for future products or services. Because the money has not yet been earned, the seller registers it as a liability.
Unlike accounts receivable (A/R), deferred revenue is classified as a liability, since the company received cash payments upfront and has unfulfilled obligations to its customers. Therefore, if a company collects payments for products or services not actually delivered, the payment received cannot yet be counted as revenue. Under accrual accounting, the timing of revenue recognition and when revenue is considered “earned” is contingent on when the product/service is delivered to the customer. Deferred Revenue (or “unearned” revenue) is created when a company receives cash payment in advance for goods or services not yet delivered to the customer. Contracts can stipulate specific conditions, requiring no revenue to be reported before all services or goods are delivered. In other terms, the customer’s accumulated payments will stay in accrued revenue until the consumer has earned in full what was owed under the contract.
For example, if a company receives $12,000 in advance for a one-year service contract, the company would recognize $1,000 in revenue each month for the duration of the contract. The remaining $11,000 would continue to be reported as deferred revenue on the balance sheet until it’s earned. Deferred revenue is the income a company has received for goods or services that it has not yet provided. It is a prepayment by customers, and a company recognizes it as a liability on the balance sheet until it delivers the goods or services, when the revenue is recorded. Like deferred revenues, deferred expenses are not reported on the income statement. Instead, they are recorded as an asset on the balance sheet until the expenses are incurred.