Deferred Revenue Liability Calculation + Journal Entry Examples

The payment is recorded as a liability until it is earned according to the terms of the sale or the delivery of the goods/services. To record a deferred revenue journal entry, you first need to create a deferred revenue liability account. These accounts are generally current liabilities unless you expect the project to take several years. Contracts can stipulate different terms, whereby it's possible that no revenue may be recorded until all of the services or products have been delivered. In other words, the payments collected from the customer would remain in deferred revenue until the customer has received in full what was due according to the contract. Understanding the basics of accounting is vital to any business’s success.

Let us look at a detailed example of the accounting entries a company makes when deferred revenue is created and then reversed or earned. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely.

How do you record deferred revenue?

In the event that a refund is necessary, the deferred revenue that was originally booked will have to be reversed. By following these steps, businesses can ensure they accurately calculate deferred revenue and recognize the related income on the right accounting periods. In this journal entry,  the company recognizes $500 of revenue for the bookkeeping service the company has performed in October 2020. Likewise, the remaining balance of deferred revenue for the bookkeeping service here will be $2,500 (3,000 – 500). This journal entry is made to recognize the $3,000 as a liability since the company has a performance obligation to transfer the bookkeeping service to its client as it already received the money. Understanding liabilities is crucial for comprehending deferred revenue accounting.

• Then, it credits the liability account to show your obligation to provide future services.
• When an advance payment is made to cover a certain number of months, as the months go by, a certain amount of deferred revenue is earned.
• The difference between the two terms is that deferred revenue refers to goods or services a company owes to its customers.

Let’s look at a deferred revenue journal entry example for rent payments made in advance. Assume Mr. Peter is a landlord and receives a 12 months advance rent payment from his tenant. Mr. Peter will record this $12,000 received as deferred revenue in his books which will be a liability to him. Until the goods or service has been invoice template for excel delivered, unearned revenue is recorded under current liabilities, because it is expected to be settled within a year. This can only change if the advance payment made is due to be provided 12 months or more after the payment date. In such a case, the deferred revenue will appear as a long-term liability on the balance sheet.

Deferred Revenue vs. Accounts Receivable: What is the Difference?

Different business models may have different methods for recognizing deferred revenue. It’s important to understand your business model and how deferred revenue is recognized under that model. Companies should have a system in place to accurately track their deferred revenue and ensure that it’s properly classified on the balance sheet. They should also have a process for forecasting their future revenue streams based on their deferred revenue.

Deferred Revenue Example In Accounting

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. Now that we’ve looked at a  real-life example with Saleseforce.com, let’s now answer a few common questions that pop up related to Deferred Revenue. We can find the total balance of Salesforce.com’s Deferred Revenue on the Company’s Balance Sheet. In this example, we’ll look at Salesforce.com, one of the largest Customer Relationship Management (or ‘CRM’) SAAS businesses.

Smoothing of Seasonal Revenues

Deferred revenue is classified as a liability because the customer might still return the item or cancel the service. The company can make the deferred revenue journal entry by debiting the cash account and crediting the deferred revenue account. In other words, the products or services for which payment has been received will be provided at some time in the future. As a consequence, the client is owed what was purchased by the business, and payment can be returned before delivery. For example, if a company receives $12,000 in advance for a one-year service contract, the company would recognize $1,000 in revenue each month for the duration of the contract.

How do you figure out what tax bracket you’re in?

Monthly, $100 shifts from deferred to earned, leveling out by the end of the year. It’s also good practice to generate cash flow statements to best understand how deferred revenue affects cash going in and out of your business. Deferrals like deferred revenue are commonly used in accounting to accurately record income and expenses in the period they actually occurred.

Deferred revenue

The rest gets labeled as deferred revenue — until all the services have been provided. But, prepayments are liabilities because it is not yet earned, and you still owe something to a customer. The deferred revenue turns into earned revenue (which is an asset) only after the customer receives the good or service.