# Deferred Revenue

## What is it, how to record and calculate + Examples

### Table of Contents

What is Deferred Revenue?

Example of Deferred Revenue

How Deferred Revenue Works

How to Record Deferred Revenue

How to Calculate Deferred Revenue

Importance of Deferred Revenue

### What is 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 such. As a result, the unearned amount must be deferred to the company's balance sheet where it get's reported as a liability.

### 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).

### How Deferred Revenue Works

Unearned revenue is deferred revenue in accounting. Recording revenue and expenses affect a company's financial statements. Accrual accounting recognizes revenue when earned, not paid. If the service hasn't been provided, a company can't count the full payment as revenue. Instead, its balance sheet must show "deferred revenue" for the payment.

A business owes customers deferred revenue because it has been paid for by goods or services not yet given. Providing goods and services generates deferred revenue. Delivery increases recognition.

Imagine an annual software subscription company. A subscription payment made at the start of the year cannot be counted as revenue. It must record the payment as deferred revenue and recognize a portion each month as it provides the service. Revenue recognition gradually reduces deferred revenue.

Accounting defines deferred revenue as a business receiving payment for goods or services not yet delivered. As goods or services are given, revenue is recognized. This concept affects how companies record revenue and expenses in their financial statements.

### How to Record Deferred Revenue

Recording deferred revenue is a crucial part of financial accounting for businesses that receive payments in advance for goods or services that have not yet been fulfilled. Here are the steps for recording deferred revenue:

1. Identify the goods or services in question.
2. Subtract the direct costs associated with providing the goods or services from the total amount received to calculate the revenue to be deferred.
3. Record the deferred revenue on the balance sheet as a liability.
4. Gradually reduce the deferred revenue account and credit the earned revenue account as goods or services that are finalized.
5. Perform periodic audits of the deferred revenue account to ensure accuracy.
6. Train employees on the correct procedures for recording deferred revenue.

By following these steps, businesses can accurately record deferred revenue and ensure that their financial statements provide an accurate picture of the company's financial position.

### How to Calculate Deferred Revenue

In this section, we will go through the steps involved in calculating deferred revenue, including how to identify and record deferred revenue and the importance of periodic audits and system updates.

1. Determine the total amount of revenue received in advance.
2. Calculate the amount to be deferred based on the number of services that are yet to be delivered.
3. Record the deferred revenue amount as a liability on the balance sheet.

Making sure your accounting system is up-to-date will help avoid potential errors when calculating deferred revenue balance.

### Importance of Deferred Revenue

Investors value deferred revenue because it provides insight into a company's financial health. It assists investors in understanding how much cash a company has received in advance and how much revenue is yet to be earned. Deferred revenue can also assist investors in identifying businesses with long-term revenue streams, as it is frequently associated with long-term contracts or subscriptions.

Deferred revenue also aids businesses in managing cash flow. Businesses can plan their expenses and investments more effectively if they receive payment in advance. Deferred revenue is gradually recognized as earned revenue, which aids businesses in managing their financial statements and ensuring accurate reporting.

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