What does deferred revenue mean?
Paid money that hasn’t been made yet is called deferred revenue in accrual accounting.
As per the revenue recognition concept, businesses should record revenue when it is earned, which could be when a good or service is delivered, not always when cash is received.
This is why companies list deferred revenue as a current liability on their balance sheets until the goods or services are provided.
Both companies and customers like the idea of deferred revenue.
Deferred revenue lets businesses get the money they need immediately while still letting them count the income as it comes in. This helps businesses make the most of their cash flow by giving them money to run their operations immediately instead of waiting to earn it.
It also guarantees future income, which can help them predict income and make long-term strategic choices.
The customer knows they will get the goods or services they paid for because of deferred revenue. It might also give them a sales deal sometimes.
Like words
- Unearned revenue is money you get paid for services or goods you haven’t yet given to a customer.
- Deferred income is money you get ahead of time but hasn’t yet counted as income.
What is Paid-Ahead Deferred Revenue in SaaS?
Deferred revenue is popular in the software-as-a-service (SaaS) industry. Monthly and yearly subscription payments are usually taken upfront to guarantee future income.
Due to the rise of subscription business models and services that require upfront payment, the SaaS industry has seen a lot of deferred income in the past few years.
Regarding SaaS, getting paid upfront is often best for the company and the customer. This way, both parties are sure they will get the product or service they paid for, and the company has the money it needs to start running right away.
The company already has the money, so if there is a policy disagreement about refunds or cancellations, the money is already there. Customers who use the “try before you buy” strategy may hurt businesses, so this helps them stay safe.
What does “deferred revenue” mean in retail?
People usually buy things at stores at the same time they use them.
People who buy things in stores usually exchange value immediately, meaning they pay for what they want at the time of the sale. However, some retail deals involve revenue that isn’t due right away.
In retail, deferred income often comes in two forms:
Online pre-orders: People can order a product before it comes out, and the business gets paid upfront. People often pre-order things in the fashion, entertainment, and gaming businesses. Companies that put on entertainment events need to sell tickets before they happen. They might not sell out if they don’t.
Gift Cards: Businesses give gift cards to customers that they can use to buy things or get services later. When someone redeems a gift card, they get the item they bought in exchange for money already paid for by someone else.
Companies get paid before they deliver in both situations, so their financial statements will show a balance of “deferred revenue.”
Why businesses keep track of deferred revenue
Companies keep track of deferred income for several reasons, including:
When you record deferred revenues and costs, you get a more accurate picture of your finances because the income is spread out over the life of a service or contract.
Regarding operations, deferred revenue helps companies plan for the resources they will need, which helps them better handle their staff and budgets.
Businesses can keep their cash on hand and avoid cash flow problems with delayed income because it lets them know when to expect money from their revenue streams.
Banks and other lenders are more likely to give lines of credit and other forms of support to businesses that can show they can manage their money well and predict their income.
Deferred Revenue and Accounting for Accruals
When you use accrual accounting, you record income and costs as they happen, not when you get paid or when the money is received.
This way of keeping track of deals is based on the idea that matching income and costs to the same period will give a more accurate picture of how well a business is financially doing.
In accrual accounting, there are three kinds of income:
It stands for “deferred revenue.” This money has been made but is not yet shown in the financial statements as revenue.
- Accrued Revenue: This is money that has been earned but is not yet cash. This kind of income is recorded when the bill is sent to customers at the end of the accounting period.
- Revenue Recognized: Revenue that has been earned and received is called revenue that has been recognized. When cash comes in from a customer, this kind of income is recorded.
- When businesses record delayed revenues, they also record a liability, which is their duty to provide goods or services in exchange for already received money.
- A deferred revenue debt is not shown on the income statement. It is put on hold until the goods or services are provided.
What Is the Difference Between Recognized and Deferred Revenue?
ASC 606 and GAAP rules say businesses can only record income once earned or realized.
You have to give the customer something of value in return for their money before you can record the revenue on the income statement.
When a business gets money before the goods or services are provided, that money is called deferred revenue. This is why it is not shown as revenue on the income statement.
Based on these accounting rules, it should be shown on the balance sheet as a liability until the goods or services are provided and the money can be recognized as revenue.
Earned Revenue vs. Deferred Revenue
Both deferred and unearned revenue mean the same thing: money customers pay for things or services before they are delivered.
On the balance sheet, deferred revenue is shown as a debt. Unearned income, on the other hand, is just an entry in the general ledger.
Businesses may use both terms sometimes without a problem. Some people might tell the difference between the two by saying that delayed revenue is money that has already been received, and unearned income is money that is expected but has not yet been received.
Revenue in the Short Term vs. Revenue in the Future
Short-term and deferred revenue are two different financial ideas that affect how a business reports its finances and rates its success. When a company makes money through its main business activities within a specific reporting time, usually within the next 12 months, that’s called short-term revenue. It’s also called recognized or earned revenue. It shows up on the income statement when the goods or services are delivered to customers, showing a quick cash flow.
On the other hand, delayed revenue, also called unearned revenue, is money that a business has already received from customers in advance for goods or services that have not yet been provided. It shows up as a liability on the balance sheet until the company pays its bills. Once it does, it slowly shows up as cash on the income statement. The difference between these two ideas is when revenue is recognized: short-term revenue is based on current sales. In contrast, delayed revenue is based on future obligations and shows that a company is committed to keeping its promises to customers over time.
Figuring out and recording deferred revenue
Here’s how to figure out and record delayed revenue:
- When a business gets paid ahead of time for goods or services, it needs to figure out how much-deferred income it has. To do this, the business would take the total amount of money it got and subtract the amount it thought it would cost to send the goods or services.
- 2. The amount that is left over is then shown on the balance sheet as a debt.
- Once the goods and services are provided to the customer, the company can show the deferred revenue recognized on its income statement.
- The amount of the previously shown debt is then taken off the balance sheet and matched up with an item in the income statement. This ensures that the company’s financial statements are correct and up-to-date for the current accounting period.
Technology for Recognizing Revenue
Many businesses use “revenue recognition automation” technology to simplify their financial tasks as they become more digital.
This technology uses complex formulas to recognize income automatically. This eliminates the need to enter data by hand and helps ensure that everything is correct.
