What is deferred revenue?
Deferred revenue refers to a payment that a company has received for goods or services that it hasn’t yet delivered.
The term is used in accrual counting, in which income is only recorded once it is earned, i.e. the product or service has been completed or delivered. Until that happens, deferred revenue is considered a liability, instead of an asset.
Why is deferred revenue important?
Properly reporting deferred revenue is important because it helps a company more accurately assess its net worth. Given that deferred revenue is a liability, keeping track of it makes sure companies don’t become inaccurately overvalued.
Similarly, keeping track of deferred revenue gives a company a better idea of its full financial picture. If a company doesn’t take deferred revenue into account, it could start spending that money on other endeavors, leaving it without enough funds to complete the products that the customer ordered.
Deferred revenue examples
Common examples of deferred revenue are:
- Annual subscriptions to SaaS products
- Advance rent or insurance payments
For example, let’s say you wanted to pre-order a new video game that is coming out. If you pay the store $60 for the pre-order, that would be considered deferred revenue because the store has not provided you with the product yet, resulting in your pre-order being a liability for the game store.
Tips for deferred revenue accounting
To account for deferred revenue, start by identifying the time period you’re looking at. Then, take note of all the transactions for which you have received payment but are yet to deliver the product.
The next step is to fill in the balance sheet. Once you have actually earned the revenue, you can update the entry in the balance sheet to reflect that by reducing the liability and moving it to an income statement.
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