Deferred revenue, sometimes called unearned revenue or deferred income, represents revenue that has been received but has not yet been earned. It appears as a liability on a company’s balance sheet.
Deferred revenue occurs when a company receives payment from a customer for products or services that will be provided in the future.
Some common examples of deferred revenue include:
The formula for calculating deferred revenue can be expressed as:
Deferred Revenue = Total Amount Received / Number of Recognition Periods
To calculate deferred revenue, you can follow these steps:
An example would be a company received $24,000 in advance for a two-year software subscription service. It would recognize this deferred revenue evenly over the two-year period.
2 Year Subscription
Using the formula and chart above, we can calculate the deferred revenue.
Deferred Revenue = $24,000 / 2 years = $12,000 per year
This means that at the end of each year, it would recognize $12,000 as revenue from the deferred revenue account.
Deferred revenue is a liability, not an asset. It represents money received by a company in advance for goods or services that have not yet been provided or earned. When a company receives payment for products or services before delivering them, it creates a liability on its balance sheet called “deferred revenue.”
Here’s why deferred revenue is considered a liability:
As the company delivers the products or services or meets its obligations over time, the deferred revenue is gradually reclassified from a liability to revenue on the income statement. This process reflects the conversion of the unearned revenue into earned revenue as the goods or services are provided.
To record deferred revenue on a balance sheet, follow these steps:
Here’s an example:
Suppose a company receives $12,000 for an annual software subscription. To record this on the balance sheet:
Identify the deferred revenue amount: $12,000.
Create or locate an “Unearned Revenue” account on the balance sheet’s liability side.
Debit the “Unearned Revenue” account with $12,000.
Credit the “Subscription Revenue” account (or a similar revenue account) with $12,000 to match the debit.
Over the course of the year, the company would gradually recognize the deferred revenue by debiting the “Subscription Revenue” account and crediting the “Unearned Revenue” account as it provides the software services each month. This process reflects the conversion of deferred revenue into earned revenue as you fulfill your obligations to the customer.