Deferred Revenue (Income)

What is Deferred Revenue (Deferred Income)?

Deferred revenue is the amount of income earned by the company for the goods sold or the services, however, the product or service delivery is still pending and examples include like advance premium received by the insurance companies for prepaid insurance policies, etc.

Thus, the Company reports it as a deferred revenue a liability than an asset until the time it delivers the products and services. It is also called as unearned revenue or deferred income.

Examples

A good example is that of a magazine subscription business where this revenue is a part of the business. Suppose a customer has subscribed for a monthly magazine subscription for one year and paid the whole amount. Let us assume that the customer pays $1200 for the 1-year magazine subscription. The customer will receive the first edition as soon as he pays and rests 11 editions every month as they are published. Thus, the Company will account for the cost of 11 magazines to be delivered in the future as unearned revenueUnearned RevenueUnearned revenue is the advance payment received by the firm for goods or services that have yet to be delivered. In other words, it comprises the amount received for the goods delivery that will take place at a future date.read more and as a deferred revenue liability. Now, as the Company starts delivering these magazines, the Company will realize them from unearned revenue liability to assets.

Deferred Revenue

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Source: Deferred Revenue (Income) (wallstreetmojo.com)

Other examples are:

  • Service contracts like cleaning, housekeeping, etc.
  • Insurance contracts
  • Rent paid in advance
  • Appliance services contracts like Air conditioners, water purifiers
  • Tickets sold for events like sports events, concerts
Deferred Revenue

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Source: Deferred Revenue (Income) (wallstreetmojo.com)

Deferred Revenue on Balance Sheet

Typically, it is reported under current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc.read more. However, if the deferred income is not expected to be realized as actual revenue, then it can be reported as a long-term liability.

As we see from below, Salesforce.com deferred income is reported under the current liability section. It is $7094,705 in FY2018 and $5542802 in FY2017.

Deferred Revenue Liability

source: Salesforce SEC Filings

Salesforce Example

Deferred income in Salesforce consists of billing to customers for their subscription services. Most of the subscription and support services are issued with annual terms resulting in deferred income.

Deferred Revenue Seasonality

source: Salesforce SEC Filings

As we note from below, deferred income is reported as the largest in the January quarter, where most of the large enterprise accounts buy their subscription services. Please note that Salesforce follows the fiscal year with 31st January year-end.

Deferred Revenue Salesforce

source: Salesforce SEC Filings

Deferred Revenue Accounting

suppose a Company XYZ hires a housekeeping Company MNC to look after the cleaning and maintenance of its offices. The contract is for 12 months, and the Company XYZ pays $ 12,000 in advance for a year. Thus, at the start of the contract and time of payment, MNC has not yet earned $ 12,000 and will record it:

AccountDebitCredit
Cash$12,000
Deferred Revenue$12,000

It is how Deferred Revenue on the Balance Sheet will look like

Deferred Revenue Accounting

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Source: Deferred Revenue (Income) (wallstreetmojo.com)

Now, after working for a month, MNC has earned $ 1000, i.e., it has provided its services to XYZ. Thus it will accrue its earning

AccountDebitCredit
Deferred Revenue$1,000
Service Revenue$1,000

Hence, $ 1000 of deferred income will be recognized as service revenue. Service revenue will, in turn, affect the Profit and Loss Account in the Shareholders Equity section.

Deferred Revenue Accounting 1

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Source: Deferred Revenue (Income) (wallstreetmojo.com)

Deferred Revenue Recognition

Deferred income should be recognized when the Company has received payment in advance for a product/service to be delivered in the future. Such payments are not realized as revenue and do not affect the net profit or loss.

Deferred revenue recognition in a 2-way step:

  • Increasing the cash and increasing deposit/deferred income on the liability side
  • After the service is provided decreasing deposit/deferred income and increasing the revenue account

Similarly, this will impact the Cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities.read more of the Company:

Time to Realise deferred income

The time of reporting real revenue may depend on the contract terms and conditions. Some may record real revenue every month by debitDebitDebit is an entry in the books of accounts, which either increases the assets or decreases the liabilities. According to the double-entry system, the total debits should always be equal to the total credits.read more the deferred income partially while others may be required to do so after all the products and services are delivered. In such cases, this may lead to varied net profits/losses reported by the Company. The Company may have a period of high profits (when this revenue is realized as actual revenue), followed by periods of low profits.

Why do Companies Report deferred income?

While the Companies do not have a choice as per the accounting principlesAccounting PrinciplesAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts.read more to not to record deferred income, however, there are many advantages of doing so:

Final Thoughts

Deferred revenue accounting is a critical concept to avoid misreporting of assets and liabilities. It is majorly essential for Companies that get advance payments before it delivers its products and services. The bottom line is that once the Company receives money instead of goods and services to be done in the future, it should report it as deferred income liability. It will realize such revenue only after the goods and services are provided to the customers. If the Company realizes the revenue as it receives the money, it will overstate its sales. However, deferred income is essential to the Company as they help it to manage its finances and cover the cost of operating activitiesOperating ActivitiesOperating activities generate the majority of the company's cash flows since they are directly linked to the company's core business activities such as sales, distribution, and production.read more.

Deferred Revenue (Income) Video

This article has been a guide to what is Deferred Revenues on Balance Sheet and its definition. Here we discuss how to account for deferred revenue and reasons why companies report deferred income. You may also have a look at these articles below on accounting basics –

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