Deferred Revenue Journal EntryLearn how to record journal entries for deferred revenue

The main purpose of forming and eventually running a business is to earn profits.

A business usually earns profits from its operations which create revenue.

For example, the sale of a product creates sales revenue.

The sale of service creates service revenue.

Usually, a customer either pays for a product or service whenever s/he receives it.

Or, if the business allows it, the customer may pay for the product or service at a later date.

This creates an asset – accounts receivable- on the part of the business.

This asset will represent the fact that the business has a receivable (usually cash) from the customer.

Recording accounts receivable also allows the business to record revenue even without the outright receipt of cash.

The business only needs to earn revenue and it’s all good.

But what if it’s the opposite situation?

For example, a customer pays in advance for a service that the business will perform at a future date.

How should the business account for it?

Well, if the business is using the cash accounting method, the business just simply has to record the transaction as revenue.

This is because under the cash accounting method, whenever there is a cash receipt, there is a corresponding revenue (except for some cases).

However, if a business is using the accrual accounting method, how would it record such a transaction?

Is a business allowed to not record the transaction until it performs the service?

Or, since the business has already received cash, should it record revenue too?

To answer the above questions, we need to learn about deferred revenue and its corresponding journal entries (under the accrual accounting method), which is what this article is all about.

So read on to learn about deferred revenue and its corresponding journal entries.

What is Deferred Revenue?

Deferred revenue is a product of the accrual accounting method which operates on the principle that revenue should only be recognized when it’s earned, and likewise, expenses should only be recognized when incurred.

As such, when a business receives payment for goods or services that it has yet to deliver, there is a need to defer the recognition of revenue.

This deferment of revenue results in the creation of deferred revenue.

When the business finally delivers the goods or services, deferred revenue becomes earned revenue.

Deferred revenue represents revenue that the business has yet to earn through the sale of goods or services.

It arises when the business receives an advance payment.

Since the business has already received payment for this future sale, it needs to record the receipt of cash.

However, since the business cannot record revenue yet, it needs to use another account to complete the journal entry for the cash receipt.

That’s where deferred revenue comes in.

Deferred revenue is a liability account.

It represents an obligation to deliver goods or services in exchange for the payment that the business has already received.

Deferred revenue is more common for service businesses which typically require an advance or down payment before the delivery of services.

Here are some examples of situations that may lead to the recognition of deferred revenue:

• Customers may pre-order products that are yet to be released (this is usually the case for videogames or collectibles). Usually, stores that allow pre-orders require a deposit from the customer. This deposit leads to the recognition of deferred revenue.
• In the case of highly personalized products, a business may require advance payment as a form of security.
• Subscription services usually offer annual subscriptions that are cheaper than monthly subscriptions. If a customer avails of an annual subscription, it creates deferred revenue.

Recording Deferred Revenue Journal Entries

Under the accrual accounting method, a business has to record transactions as they occur, regardless of whether they involve cash or not.

In the case of deferred revenue, it only arises when the business receives payment for services or goods that it has yet to deliver.

Thus, an increase in the deferred revenue account will always be accompanied by an increase in cash or a similar asset.

To illustrate, let’s have an example.

Let’s say that you’re operating a business that offers cleaning services.

A customer avails of your services.

He says that he needs you to perform cleaning services five days from now.

He pays $3,000 as full payment for the said service.

This situation creates deferred revenue as there is payment for services that you are yet to deliver.

To record this transaction, the journal entry would look like this:

The $3,000 deferred service revenue represents an obligation to perform services on a future date.

Now let’s say that you successfully deliver cleaning services on the agreed-upon date.

This means that you finally earn the revenue related to the advance payment.

As such, there is a need to recognize the deferred service revenue as earned revenue.

The journal entry for such recognition would look like this:

This $3,000 service revenue will then appear on your business’s income statement.

Do note that while deferred revenue is almost always a current liability, it may also be a non-current liability in certain circumstances.

For example, if an advertising company receives the full payment for a 5-year advertising contract, then this receipt of advance payment creates deferred revenue that has current and non-current components.

Its advertising obligation for the current year represents the current deferred revenue.

The advertising obligation for the rest of the contract represents the non-current deferred revenue.

Some Pointers About Deferred Revenue

Still unsure whether a transaction necessitates the recognition of deferred revenue?

Here are some pointers to make things easier:

• If there is payment for a service or product that is yet to be delivered, there is a need to record deferred revenue
• If you receive a payment that covers multiple periods (such as in the case of subscription services), it will lead to the creation of deferred revenue
• You usually can’t have accounts receivable and deferred revenue in the same journal entry. This is because accounts receivable arise from the accrual of revenue. On the other hand, deferred revenue is the result of the deferment of revenue. So if a transaction involves accounts receivable, there is a good chance that it doesn’t involve deferred revenue
• If your business always requires a downpayment or an advance, then you’ll probably have to record deferred revenue every time you receive such payments