A customer pays $1,200 in January for a subscription that covers the entire year. When the services have been completed,  you would debit expenses by $10,000 and credit prepaid expenses by $10,000. For a common example, most insurance premiums serve as deferred expenses since the customer routinely pays at the start of the coverage period. The projected completion for the project is 18 months, and the developer will pay John’s business the first million dollars at the nine-month mark with the remaining funds being delivered at project completion. A credit entry will increase deferred revenue and a debit entry will decrease it.

Revenue Recognition

Deferred revenue and accrued revenue are two different concepts, but they are both rooted in the principle of accrual accounting and serve a common goal of making your financials as accurate as possible. They relate to the timing of revenue recognition, serving as placeholders on your balance sheet until you’ve either earned or paid what’s due. Deferred revenue is recorded as a liability on the balance sheet, and the balance sheet’s cash (asset) account is increased by the amount received. Once the income is earned, the liability account is reduced, and the income statement’s revenue account is increased.

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1. The software provider is then obligated to provide access to the check-in system for the next 12 months.
2. Generally accepted accounting principles (GAAP) require businesses to recognize revenue when it’s earned and expenses as they’re incurred.
3. While deferred revenue presents challenges, proactive management and the right tools can help businesses address these challenges effectively.
4. According to cash basis accounting, you “earn” sales revenue the moment you get a cash payment, end of story.

Deferred revenue is recorded as such because it’s money that hasn’t yet been earned. When actually tracking both accrued and deferred revenues, many businesses don’t recognize these adjustments in real-time. Instead, they commonly ignore any accrued deferred revenue vs accrued revenue revenue while tracking deferred revenue the same as any other payment. At the end of the accounting period, however, the relevant accounting department will create adjusted journal entries as part of the closing process. Assume a customer makes a $10,000 advance payment in January for products you’re driving to be delivered in April. You would record it as a $10,000 debit to cash and a $10,000 deferred revenue credit.The receipt of payment has no bearing on when revenue is received using this method.

As a business fulfills its obligation, it should reduce the current liability of unearned income and record it on the income statement as earned income. Deferred or unearned income is often received in the form of advance payment. As long as it continues operating as it has been, that deferred revenue will eventually appear on the income statement. And if most of a company’s business comes from long-term contracts, deferred revenue can make its future earnings much more predictable. Add up the amount of revenue from all customers who have received services in a particular period but have not yet been billed. When you record accumulated revenue, you recognize the income owed to you that still needs to be paid.

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If a company recorded all its customers’ up-front payments as revenue when it received them, it may show much more in profits in the period where it originally made those sales. Sometimes businesses take an advance payment on a good or service meaning they’ve been paid upfront and now they need to fulfill their end of the deal. Deferred revenue is earned when a company collects money for a service it has yet to provide. This usually happens for service companies that wait to perform the job until at least a portion of the job is paid for. A company incurs deferred revenue by following through on its end of the contract after payment has been made.

When the cash eventually comes in, that asset is converted into recognized revenue. Deferred revenue is payment received from a customer before a product or service has been delivered. Deferred revenue, which is also referred to as unearned revenue, is listed as a liability on the balance sheet because, under accrual accounting, the revenue recognition process has not been completed. Unlike accrued revenue, deferred revenue is considered a liability because the company has a legal obligation to provide the service or product in the future. Businesses must handle accrued revenue according to the accrual accounting principle, one of the fundamental principles of accounting.

Why companies use it

Accrued and deferred revenues are contrasting accounting entries for a business. In the end, an efficient, reliable financial planning and analysis process (FP&A) is at the heart of effectively managing accrued revenue and other metrics and setting a solid foundation for your company’s growth. Say Company A provides advertising services and charges clients based on the number of ad impressions delivered. Bench gives you a dedicated bookkeeper supported by a team of knowledgeable small business experts. Your bookkeeping team imports bank statements, categorizes transactions, and prepares financial statements every month. Because the membership entitles Sam to 12 months of gym use, you decide to recognize $200 of the deferred revenue every month—$2,400 divided by 12.

By tracking accrued revenue, you can better understand your company’s cash flow situation, assess its financial health with revenue forecasting, and make informed decisions about future investments or expenses. Plus, aligning revenue recognition with service delivery gives you a more precise measure of the company’s profitability and operational efficiency. In contrast, deferred revenue refers to money not earned yet, meaning customers have paid you even though you haven’t (completely) provided the services. Accrued revenue helps you understand how much income you’ve truly earned in a month and gives you real-time insights into your company’s operational efficiency and financial health. By matching revenue earned with the services provided within the same period, regardless of when the payment is received, you’ll have a clearer picture of your company’s immediate financial performance.

One example of a deferred revenue journal entry is when a company receives payment for services or goods that have not yet been provided. Another example is when a company provides subscription services and receives customer advance payments. The company would debit the cash account and credit the deferred revenue account in this scenario. As the services are provided over time, the company would then recognize the revenue by debiting the deferred revenue account and crediting the revenue account to reflect the revenue when it is earned. In other words, accrual accounting focuses on the timing of the work that a business does to earn revenue, rather than focusing on the timing of payment.

If a client pays you in advance for a six-month project, that payment initially goes into deferred revenue. As you complete the work each month, you’ll gradually move amounts from deferred revenue to earned revenue. In accrual accounting, a liability is a future financial obligation of a company based on previous business activity. Liabilities are often oversimplified as the debt of a company that must be paid in the future. For example, let’s say a company provides a subscription service to customers for $100 per month.