Deferred revenue refers to the payment from the clients for the goods and services they will receive in the future. In this case, the seller has to record this as a liability since he has not earned the revenue (Also see How Should We Classify Unearned Revenue?). To insurance agents and software providers, deferred revenue is something common as they will require advanced payments as they are going to provide the service for a period, probably for many months.
Recognition of Deferred Revenue
Eventually, the recipient will earn the revenue, and this reduces the balances of the deferred revenue account, which has a debit balance. At the same time, it will increase the balances of the revenue account, which has a credit balance. According to the contract terms, there is a possibility where the selling entity can only recognise the revenue when it has delivered the goods or provided all the services. Hence, at the early stage, the business may show losses, but this will be followed by profits afterwards.
Typically, the deferred revenue account falls into the category of current liability in the company’s balance sheet. If the company does not expect to see its performance in the next 12 months, then it can classify it as a long-term liability.
Accounting (Also see An Overview of Accounting Procedures) for Deferred Revenue
As an instance, XYZ corporation employs Spring Garden to mow its lawns. XYZ corporation paid RM12,000 in advance to Spring Garden as they request them to give the priority of mowing their lawns first. When XYZ corporation pays the fees, Spring Garden has not earned the revenue (Also see The Concept of Revenue Recognition) yet. Therefore, Spring Garden will record the RM12,000 in the deferred revenue account by using the entry below:
– Debit RM12,000 to cash
– Credit RM12,000 to deferred revenue (liability)
Spring Garden has agreed to mow the lawns for XYZ corporation for a year. So, throughout the 12 months, Spring Garden will recognise RM1,000 of the deferred revenue monthly. The entry it records will be:
– Debit RM1,000 to deferred revenue (liability)
– Credit RM1,000 to moving revenue (revenue)
It may be difficult for you to understand the concept of deferred revenue, especially if accounting (Also see Comparing Computerised Accounting and Manual Accounting) is not your thing. Thus, as a business owner, you should consider hiring an accounting firm Singapore so that you can always keep a tight grip on your business’s finances.