There are some accounting terms that are difficult for us non- accountant types to wrap our head around. Deferred revenue is definitely one of them. Sometimes called deferred income, or unearned revenue, deferred revenue is money a company has received for goods/services that haven’t been delivered to the customer - revenue that hasn’t been earned yet.
As the good/ service is delivered it’s 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 is 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. As the business delivers the product 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 is not only realized (cash has been received) but earned (a good/service has been provided). Until it’s 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 the accounting for subscription businesses.
Deferred Revenue Example
Like many subscription businesses, GoToMeeting offers each of its plans as monthly (credit card is charged once a month) or yearly (card is charged all at once for a year’s worth of service.)
Since deferred revenue represents the value of the services that are left to be delivered at a point in time, if I purchased the annual plan, my $3,828 would be added to both the cash account of the balance sheet and the deferred revenue line. Every month $319.00 would be moved out of deferred revenue and reported as revenue on the 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. You may be able to deal with this for a handful of customers, but hundreds? Thousands? No way.
In addition to this, ASC 606 revenue recognition standards are applicable to companies in the US and have taken 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 recognize their revenue in a way that is compliant, which requires the ability to track their earned and deferred revenue over the entire period of the subscription.
An automated billing system that adheres to industry standard accounting practices is really the best option for a subscription based company. Since Fusebill was designed by accountants and backed by a general ledger, it is built to deal with complexities like deferred revenue so you don’t have to.
Fusebill supports the revenue recognition requirements laid out in ASC 606 for recurring revenue and can help any subscription business become compliant.
Did this article help with your understanding of deferred revenue? Or do you have anything to add?