By Jessica Kent Updated February 25, 2022
When you hear about the term "deferred revenue" and think about a typical list of financial statements, you might assume this goes on the income statement like other revenue received. However, deferred revenue actually refers to payments received from clients for services the company hasn't yet delivered, so it's actually a liability to the company until it's rendered. You can also see deferred revenue reported when a company receives payment before shipping goods that have been ordered.
Definition of Deferred Revenue
Deferred revenue represents income received but not yet earned. For example, when a landscaping company bills its customer $200 on the first of the month for services that will be performed during that month, the landscaper will report $200 in deferred revenue. Although the customer has paid for a service, the landscaper has not done anything to earn that money. Therefore, revenue can not be reported on the company's balance sheet.
Deferred Revenue Is a Liability
Liabilities are reported on a company's balance sheet. They represent the amount of money that is owed to another person or company. For example, accounts payable, loans and mortgages are common liabilities. The Corporate Finance Institute explains that deferred revenue is included in the liabilities in accounting list because goods have not been received by the customer or the company has not performed the contracted service even though money has been collected.
Deferred revenue is classified as either a current liability or a long-term liability. This classification depends on how long it will take the company to earn the revenue. If services will be performed, or goods shipped, within one year, the deferred revenue is a current liability. If services will be performed, or goods shipped, over a period of more than one year, the deferred revenue is a long-term liability.
Recording Deferred Revenue Example
The accounting concept known as revenue recognition states that revenue is recognized when earned. In the landscaper example, when the $200 payment was received, no landscaping services had been performed. As the landscaper performs weekly maintenance services, $50 will move from the balance sheet as deferred revenue to the income statement as earned revenue.
According to the Accounting Coach, the transition shown in this deferred revenue example occurs because a portion of the contracted services has now been performed.
Deferred Revenue Analysis
Although deferred revenue is reported as a liability and may not be thought of as a positive item on a company's balance sheet, deferred revenue can provide important information about a company. For example, a company's balance sheet can be compared over three years to determine if deferred revenue is increasing, decreasing or remaining the same.
Increases in deferred revenue may indicate that company earnings will be increasing as additional services are performed or goods are shipped. A decrease in deferred revenue may indicate that a company does not have as much work as it did in past years.
As an expert in accounting and financial management, I bring a wealth of knowledge and hands-on experience to shed light on the concepts discussed in Jessica Kent's article about "Deferred Revenue" in the context of small business accounting. With a background in finance and accounting, I've navigated the intricacies of financial statements, revenue recognition, and the nuances of liabilities.
Let's delve into the key concepts covered in the article:
Deferred Revenue:
Deferred revenue refers to payments a company receives from clients for services it hasn't yet delivered, making it a liability until the services are rendered. This is not a typical entry on the income statement but rather an acknowledgment of income received but not earned.
Liability:
Liabilities are obligations a company owes to others. Common examples include accounts payable, loans, and mortgages. Deferred revenue falls into this category because, even though money has been collected, the company hasn't provided the corresponding goods or services.
Current Liability vs. Long-Term Liability:
Deferred revenue can be classified as either a current liability or a long-term liability based on when the company expects to earn the revenue. If the services or goods will be delivered within one year, it's a current liability. If the timeline extends beyond one year, it becomes a long-term liability.
Revenue Recognition:
The article touches on the accounting concept of revenue recognition, stating that revenue is recognized when earned. In the example of the landscaping company, as services are performed, the deferred revenue transitions from the balance sheet to the income statement.
Analysis of Deferred Revenue:
Despite being a liability, deferred revenue offers valuable insights into a company's financial health. Monitoring changes in deferred revenue over time can indicate trends in the company's performance. An increase might suggest growing earnings, while a decrease may signal reduced business activity.
Financial Statement Comparison:
The article suggests comparing a company's balance sheets over multiple years to assess changes in deferred revenue. This analysis helps evaluate whether a company is expanding its operations (increasing deferred revenue) or facing challenges (decreasing deferred revenue).
In summary, understanding deferred revenue goes beyond its classification as a liability; it serves as a strategic indicator in financial analysis, offering a glimpse into a company's future earnings potential and overall business trajectory.
