There are some accounting terms that are difficult for us non-accountant types to wrap our heads around. Deferred revenue is definitely one of them.
Sometimes called deferred income or unearned revenue, deferred revenue is money a business has received for products or services that haven’t yet been delivered to the customer—revenue that hasn’t been earned yet.
As the products or services are delivered, the money is recognized as revenue on the business’s income statement. Before delivery, it’s recorded as a liability on the balance sheet because it’s income that hasn’t actually been earned. This 'unearned' income is what’s referred to as deferred revenue.
Deferred revenue refers to advance payments—such as in the case of subscription-based businesses—that a business receives for products or services to be delivered at a future time or over a specified period. As the business delivers the products or services, more of the deferred revenue is gradually 'recognized'. This recognized revenue is the earned revenue.
Revenue recognition principle
If you’re like me, you’re probably wondering why you can’t just record the revenue when you receive the money. It’s because of the revenue recognition principle which states you should only record revenue that’s not only been realized (cash has been received) but also earned (a product/service has been provided).
According to the GAAP ASC 606 standard, revenue can only be recognized when value has been received by the customer. And until it’s recognized or earned, the money received is a liability because it signifies an obligation to the customer.
Knowing how to deal with deferred revenue properly is a very big part of accounting for subscription businesses.
Deferred revenue example
Like many subscription businesses, GoToMeeting offers each of its plans on a monthly (credit card is charged once a month) and yearly (card is charged all at once for a year’s worth of service) recurring payment schedule.
Since deferred revenue represents the value of the services that are left to be delivered at a point in time, if I purchased the GoToWebinar annual plan for up to 500 attendees:
- $3,828 would be added to both the cash account of the business’s balance sheet and the deferred revenue line.
- Every month as I received the service, $319.00 would be moved out of deferred revenue and reported as revenue on the business’s income statement.
Manual nightmare for calculating deferred revenue
For a subscription business to try and deal with this manually would be a nightmare, and scalability would be impossible. A successful subscription business can generate over a million journal entries, or records of business transactions, each month.
You may be able to deal with this for a handful of customers, but hundreds? Thousands? No way.
In addition to this, the ASC 606 revenue recognition standard discussed earlier is applicable to businesses in the U.S. and took effect for public companies on Jan 1, 2018 and for private companies on Jan 1, 2019.
Adopting ASC 606 mean SaaS, IoT, or any other subscription-based businesses need to recognize their revenue in a way that’s compliant, which requires the ability to track their earned and deferred revenue over the entire period of their customers’ subscriptions.
The revenue recognition solution
An automated billing system that adheres to industry standard accounting practices is really the best option for a subscription based business to accurately recognize its revenue.
Since Fusebill was designed by accountants and backed by a general ledger, it’s built to deal with complexities like deferred revenue so you don’t have to. It can also easily manage the various other complexities that can come up for a subscription based business, such as recognizing revenue for:
- one-time fees
- mid-term subscription changes, and
- usage based billing.
Fusebill supports the revenue recognition requirements laid out in ASC 606 for recurring revenue and allows any subscription business to take necessary steps towards compliance.
Did this article help with your understanding of deferred revenue? If you have more questions, you can talk with one of our billing experts who are always happy to answer any questions you might have.