Deferred revenue is money received by a company before it provides the related goods or services to the customer.The balance sheet shows it as a liability.Deferred revenue transactions are common for companies of all sizes and industries.You can learn how to record deferred revenue with some understanding of the underlying accounting concepts behind it.
Step 1: You should be familiar with the accrual basis of accounting.
Deferred revenue is a part of the accrual basis of accounting.Revenues are recorded on the income statement when they are earned rather than received.The cash basis of accounting is different.
Step 2: Understand why revenue should be deferred.
The revenue recognition principle requires you to defer revenue.The revenue recognition principle requires accountants to show revenues on the income statement when they are earned, not when the cash is collected.There needs to be a difference between realized and earned revenue.Regardless of whether the company has fulfilled its obligations to the purchaser, real revenue is received.Deferred revenue is the subset of revenue which is real.A magazine company can get a twelve-month subscription for a monthly publication.Up front, the subscriber pays the entire cost of the subscription.The $120 is a liability to the company because it is classified as deferred revenue.The revenue has been realized but not earned.
Step 3: Deferred revenue transactions should be identified.
Deferred revenue deals with revenue that is realized in one reporting period but not earned in the next.Depending on the company, the reporting period can be monthly, quarterly, or annually.The company has already received payment for all customer orders that haven't been fulfilled yet.The transaction should be reported as deferred revenue.This includes items that have been paid in full but await shipment, as well as subscription-based revenues where the subscription period is still ongoing.The accounting staff must calculate and record the amount of deferral once these transactions have been identified.
Step 4: Don't forget to record the revenue.
The company's balance sheet is recorded as deferred revenue.The company gets cash and records deferred revenue on the balance sheet.The company gets an advance payment for a twelve-month magazine subscription.Before delivering the subscription, the company must record the entire amount of payment as deferred revenue.The accounting staff will post a journal entry about Debit Cash $120 Credit Deferred Revenue.
Step 5: The earned revenue should be recorded.
The balance sheet and income statement are affected by this journal entry.The entry is updated by transferring the amount to the income statement and reducing the balance sheet liability.Take the magazine subscription example.After the first month of the subscription, $10 has been earned and the deferred revenue amount is $110.The accounting staff will use the journal entry to transfer $10 from the deferred revenue account to earned revenue.
Step 6: The ledger needs to be adjusted until all revenue is earned.
Over the course of the service, the company's accountants must keep adjusting the balance sheet and income sheet.The liability to the customer will be zero until the company has fulfilled its obligations.The deferred revenue account has a balance of $0 and $120 of revenue has been recognized.