Accrued vs Deferred Revenue: Understanding the Difference

When any payments are received, the deferred revenue liability is recorded in the credit side of the company balance. As the services are provided, the deferred revenue liability is reduced on the debit side, and the earned revenue is recognized. This accounting treatment demonstrates that the company still owes the customer and protects the company from overstating its value. Customer payments for products or services they anticipate receiving in the future are known as deferred revenues.

Deferred revenue is listed on the balance sheet under liabilities and it to be added to the income statement later. Deferrals like deferred revenue are commonly used in accounting to accurately record income and expenses in the period they actually occurred. When a legal practice charges a new client a $10,000 retainer fee, it isn’t immediately recorded as revenue in its books. It records it as deferred revenue first, and only records $10,000 in revenue after the entire retainer fee has been earned.

Other frequently asked questions about deferred revenue journal entries

It means that the $12,000 deferred revenue turns into revenue gradually with each month as the subscription progresses. While exploring the concepts of accrued and deferred revenues, it’s wise to also consider the inverse of these tracking methods, accrued and deferred expenses. Bob D. Ferd is the founder of a boutique software company that offers one product—a cloud-based patient check-in system. Ferd’s company sells licenses for this software to medical offices on a yearly basis, meaning that all of the organization’s customers pay the full cost up-front. The software provider is then obligated to provide access to the check-in system for the next 12 months. Subscription management capabilities allow companies to accurately track deferred revenue and recognize revenue when goods or services are delivered.

As you follow this tutorial, you will be amazed by how easy modeling deferred revenue can be. Deferred revenue is a popular concept among both businesses and customers. At Bench, we work with you to ensure your financial reporting needs are met while keeping you IRS compliant. We do this by automatically importing all of your business transactions into our platform for your personal bookkeeper to categorize and review. They’re available to you by message or appointment to go over your books and review key information.

Why is deferred revenue considered a liability?

Under accrual basis accounting, you record revenue only after it’s been earned—or “recognized,” as accountants say. When accountants talk about “revenue recognition,” they’re talking about when and how deferred revenue gets turned into earned revenue. The standard of when revenue is recognized is called the revenue recognition principle. Deferred revenue affects three key financial statements – the balance sheet, income statement, and cash flow statement. Let’s use a fictitious example to take a closer look at how deferred revenue works. A lack of internal controls can also lead to deferred revenue accounting errors.

So, in the case where the Order Date equals the Invoice Date and there is a single invoice for the subscription, the Revenue Backlog and Deferred Revenue are identical at all times. In this example, the Backlog would be 12,000 reportable as backlog from the order date of April 1 through April 15. Since there is no invoice prior to April 15, there is not deferred revenue to report between April 1 and April 15.

How to log deferred revenue journal entries

When customers pay in advance, it’s particularly important to keep accurate reports of unearned revenue, so that your company does not invest or use more of its resources than are strictly available. Businesses that provide subscription-based services routinely have to record deferred revenue. For https://investrecords.com/the-importance-of-accurate-bookkeeping-for-law-firms-a-comprehensive-guide/ 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.

It reconciles your deferred revenue account balance on your balance sheet and provides a forecast of your expected revenue stream in the future. To illustrate deferred revenue, let’s law firm bookkeeping 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.

Example How to account for deferred revenue from an annual subscription

This means the customer must receive a product or service in exchange for payment before the revenue can be recognized and recorded on the income statement. In both of these cases, companies collect payment before delivery, meaning that their financial statements will show a deferred revenue balance. Because of this, companies record deferred revenue as current liabilities on their balance sheets until the services are rendered or products are delivered. According to the revenue recognition principle, companies must recognize revenue when it is earned (i.e., when a good or service is delivered), not necessarily when cash has been received. A deferred revenue register lists income that has been promised or received but is not yet recognized as earned.

• Under accrual basis accounting, you record revenue only after it’s been earned—or “recognized,” as accountants say.
• Lastly, we create two outputs in the Outputs column to link the Income Statement and Balance Sheet outputs to their prospective financial statements.
• Deferred revenue is earned when a business performs its end of a contract after payment has been received.
• The revenue isn’t recognized as earned until the goods or services are provided.
• For this reason, unearned revenue is only shifted to the income statement after the delivery obligation has been fully met.
• Then, for the Deferred Revenue formula, we will set it to be the opposite of Revenue from Contract since Deferred Revenue is to be debited or decreased here.