What is Deferred Revenue?
Deferred revenue is a payment from a customer for future goods or services. The seller records this payment as a liability, because it has not yet been earned. Deferred revenue is common among software and insurance providers, who require up-front payments in exchange for service periods that may last for many months.
Recognition of Deferred Revenue
As the recipient earns revenue over time, it reduces the balance in the deferred revenue account (with a debit) and increases the balance in the revenue account (with a credit). Depending on the contract terms, the selling entity may not be allowed to recognize revenue until all goods have been delivered and/or services completed; this can skew the reported performance of a business to show early losses, followed by profits in later periods.
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.
Examples of Deferred Revenue
Businesses that provide subscription-based services routinely have to record deferred revenue. For example, a gym that requires an up-front annual fee must defer the amounts received and recognize them over the course of the year, as services are provided. Or, a monthly magazine charges an annual up-front subscription and then provides a dozen magazines over the following 12-month period. As yet another example, a landlord requires a rent payment by the end of the month preceding the rental usage period, and so must defer recognition of the payment until the following month.
Accounting for Deferred Revenue
For example, Alpha Corporation hires Northern Plowing to plow its parking lot, and pays $5,000 in advance, so that Northern will give the company first plowing priority throughout the winter months. At the time of payment, Northern has not yet earned the revenue, so it records all $5,000 in a deferred revenue account, using this deferred revenue journal entry:
Terms Similar to Deferred Revenue
Deferred revenue is also known as prepaid revenue or unearned revenue.
