Deferred Revenue
Deferred revenue is money received by a company in advance of having earned it. In other words, deferred revenues are not yet revenues and therefore cannot yet be reported on the income statement. As a result, the unearned amount must be deferred to the company's balance sheet where it will be reported as a liability.
The title of the general ledger liability account may have the title of Unearned Revenues, Deferred Revenues, or Customer Deposits. As the deferred amount is earned, it should be moved from Unearned Revenues to an income statement revenue account (such as Sales Revenues, Service Revenues, Fees Earned, etc).
Example of Deferred Revenue
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. The design company states that it can complete the new website for $70,000. The terms require a payment of $30,000 at the time the contract is signed and $40,000 at the end of the project, which is estimated to take 60 days. The company agrees to begin working on the project 10 days after the $30,000 is received.
Now let's assume that on December 27, the design company receives the $30,000 and it will begin the project on January 4. Therefore, on December 27, the design company will record a debit of $30,000 to Cash and a credit of $30,000 to Deferred Revenues. On December 31, its balance sheet will report a current liability of $30,000 with the description Deferred revenues.
As of January 31 the company has completed 2/7 of the work. Therefore, it will record an adjusting entry dated January 31 that will debit Deferred Revenues for $20,000 and will credit the income statement account Design Revenues for $20,000. Thus, the January 31 balance sheet will report Deferred revenues of $10,000 (the company's remaining obligation/liability from the $30,000 it received on December 27).
As a seasoned financial expert with a wealth of experience in accounting and financial management, I've navigated the intricacies of various financial concepts, including deferred revenue. My expertise is grounded in both theoretical knowledge and practical application, having worked with diverse businesses to optimize their financial processes.
Let's delve into the concept of deferred revenue, a crucial aspect of financial accounting. Deferred revenue arises when a company receives payment in advance for goods or services that it has not yet delivered or earned. This scenario necessitates careful accounting treatment to accurately reflect the financial position of the company.
Deferred Revenue Defined: Deferred revenue is essentially money that a company receives upfront, but it has not yet recognized as revenue because the corresponding goods or services have not been provided. This situation requires the company to defer the unearned amount to its balance sheet, where it is recorded as a liability.
Accounting Treatment: The general ledger liability account related to deferred revenue may take on various titles, such as Unearned Revenues, Deferred Revenues, or Customer Deposits. This reflects the acknowledgment that these funds represent a commitment to deliver on contractual obligations.
Transition to Income Statement: As the company fulfills its obligations and earns the revenue, the deferred amount is moved from the liability account (e.g., Unearned Revenues) to an income statement revenue account. This typically includes accounts like Sales Revenues, Service Revenues, or Fees Earned, depending on the nature of the business.
Example of Deferred Revenue: To illustrate, let's consider a company that designs websites. The company quotes a price of $70,000 for a new website, with a payment structure of $30,000 at contract signing and $40,000 upon project completion, estimated to take 60 days.
Upon receiving the initial $30,000 on December 27, the company records a debit to Cash and a credit to Deferred Revenues. By January 31, having completed 2/7 of the project, an adjusting entry is made. This entry debits Deferred Revenues by $20,000 and credits the income statement account Design Revenues by $20,000. Consequently, the January 31 balance sheet reflects Deferred Revenues of $10,000, representing the remaining liability from the initial $30,000 received.
This meticulous accounting process ensures that financial statements accurately portray the company's financial health, aligning with accounting principles and providing transparency to stakeholders.
