Deferred Revenue Journal Entry

A revenue deferral is an adjusting entry intended to delay a company’s revenue recognition to a future accounting period once the criteria for recorded revenue have been met. Installment sales are quite common, where products are sold on a deferred payment plan and payments are received in the future after the goods have already been delivered to the customer. Under this method, revenue can only be recognized when the actual cash is collected from the customer.

An example of a deferred expense would be pre-paid rent on office space or a storefront. Deferred expenses follow similar principles as deferred revenue, just reversed; these expenses are listed under the assets column of a balance sheet until realized. As previously mentioned, revenue that is deferred is not considered actual revenue until it is realized upon the delivery of a product or service. Because of this, it is not reported on an income statement; instead, deferred revenue is listed under the liabilities column on a balance sheet.

Accounting For Deferred Expenses

Deferred revenue in accrual accounting is rooted in the matching principle. When you invoice a company for a one-year subscription, you have not earned that revenue yet. Of course, there are so many new nuances with ASC 606 that I will assume that you are pure play SaaS. Under proper SaaS revenue recognition, your accountant will invoice the customer for $12,000.

• You must park the revenue on your balance sheet as a deferred revenue liability.
• When the deferred revenue has been earned, by the company delivering the goods or services that were paid for, the liability of deferred revenue decreases, and revenue increases.
• An example of this may include Whole Foods recognizing revenue upon the sale of groceries to customers.
• At the end of twelve months, we have recognized the full $12,000 as seen in the chart below.
• It will only be recognized on the income statement as revenue when it has been earned by delivering the prepaid goods or services to the customer.

The concept of deferred revenue arises prominently in the construction contracts where revenue is recognized based on the percentage of completion of work. Under this method, the Company recognizes revenue as certain milestones are met. One important area of the provision of services involves the accounting treatment of construction contracts. These are contracts dedicated to the construction of an asset or a combination of assets such as large ships, office buildings, and other projects that usually span multiple years. Let’s take a look at a small IT consultancy firm that contracts its services to clients on a subscription basis. These 12-month subscriptions cost $500 per month, billed as a one-time $6,000 fee.

Why is deferred revenue important for small businesses?

A deferred revenue account is used when using accrual basis accounting, not with cash basis accounting. This is because, for cash basis accounting, revenue and expenses are only recorded when cash is actually received or paid. Whereas, in accrual accounting, revenue and expense are recorded as they are incurred rather than when money actually changes hands. Hence, deferred revenue is recorded only when using accrual accounting. When the deferred revenue has been earned, by the company delivering the goods or services that were paid for, the liability of deferred revenue decreases, and revenue increases. This means that when the company later delivers the good or service owed to the customer, a deferred revenue adjusting entry is made.

Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. In May, XYZ Company sold $300,000 worth of goods to customers on credit. In June, $90,000 was collected and in September, $210,000 was collected.

When do you use deferred revenue?

If a customer pays for goods/services in advance, the company does not record any revenue on its income statement and instead records a liability on its balance sheet. Common examples of when unearned revenue is recorded include a rent payment made in advance, prepaid insurance, annual magazine subscriptions, and services contracts or goods paid in advance. We will look at the deferred revenue journal entries for these mentioned examples. Until the goods or service has been delivered, unearned revenue is recorded under current liabilities, because it is expected to be settled within a year.

• Hence, the deferred revenue adjusting entry will be a debit entry to reduce the deferred revenue account.
• Hence, the initial deferred revenue journal entry that was made when the prepayment was received will be adjusted to record when the company or individual delivers the goods or service to the customer.
• More importantly, it’s difficult to manage the financial performance of your business without proper SaaS revenue recognition.
• To visualize this, let’s take a look at a $5,000 upfront payment that qualifies as deferred revenue.
• This reduces your deferred revenue liability from $12,000 to $11,000, and your income statement now shows $1,000 of subscription revenue.
• I just started with this company and so did this accounting firm; just before me so, we have no idea how it was previously done but the owner is not happy with this process.

Common prepaid expenses may include monthly rent or insurance payments that have been paid in advance. Deferred revenue can be recorded on the cash flow statement, noted as deferred revenue. Even if you have not earned it yet, it is still money that can be spent. Of course, you will want to be sure that you can fulfill your obligations to your customer. Once the customer receives the chairs, they will pay you the $2,500 balance, which again will be recorded in deferred revenue until the next 50 chairs are completed and shipped.

Deferred revenue journal entry example 2: Services contract paid in advance

Software subscriptions are the life of every SaaS business and must be accounted for properly in your general ledger. The initial receipt of deferred revenue is straightforward since you’ve received revenue you have not how to make an invoice earned yet. Determining when the revenue has been earned can be trickier and should be done with caution. Recognizing revenue gradually helps companies match their expenses to the revenue they are actually earning.

Each month, one-twelfth of the deferred revenue will become earned revenue. You must make an adjusting entry to decrease (debit) your deferred revenue account and increase (credit) your revenue account. Under a cash basis of accounting, your accountant invoices an annual, one-year subscription for $12,000, for example. Your accountant records the entire revenue amount (from the invoice total) in a single month in your financial statements. Deferred revenue is a liability because it reflects revenue that has not been earned and represents products or services that are owed to a customer.