Deferred Revenue

Definition

Deferred revenue refers to payments received by a company for products or services that have not yet been delivered or performed. It represents a liability on the company's balance sheet, as the company has an obligation to fulfill the service or deliver the product in the future.

5 Must Know Facts For Your Next Test

1. Deferred revenue is a liability on the company's balance sheet, as the company has an obligation to fulfill the service or deliver the product in the future.
2. Deferred revenue is recognized as revenue on the income statement when the company fulfills its obligation by delivering the product or performing the service.
3. Deferred revenue is common in subscription-based businesses, where customers pay in advance for a service that will be provided over a period of time.
4. Deferred revenue can also arise in cases where a customer pays for a product or service upfront, but the company has not yet delivered the product or performed the service.
5. The recognition of deferred revenue is an important aspect of accrual accounting, as it ensures that revenue is recorded in the correct accounting period.

Review Questions

• Explain how deferred revenue differs from cash basis accounting.
  • In cash basis accounting, revenue is recognized when cash is received, regardless of when the product or service is delivered. In contrast, deferred revenue is a liability on the balance sheet, representing payments received for products or services that have not yet been delivered or performed. Under the accrual accounting method, deferred revenue is recognized as revenue on the income statement when the company fulfills its obligation by delivering the product or performing the service.
• Describe the impact of deferred revenue on a company's financial statements.
  • Deferred revenue has a significant impact on a company's financial statements. On the balance sheet, deferred revenue is recorded as a liability, representing the company's obligation to deliver the product or perform the service in the future. This liability is then recognized as revenue on the income statement when the company fulfills its obligation. The recognition of deferred revenue ensures that revenue is recorded in the correct accounting period, providing a more accurate representation of the company's financial performance.
• Analyze the role of deferred revenue in subscription-based business models.
  • Deferred revenue is particularly important in subscription-based business models, where customers pay in advance for a service that will be provided over a period of time. In these cases, the company records the initial payment as deferred revenue on the balance sheet. As the company fulfills its obligation by providing the service over the subscription period, the deferred revenue is recognized as revenue on the income statement. This allows the company to match the recognition of revenue with the delivery of the service, providing a more accurate representation of the company's financial performance and cash flow.

Related terms

Accrual Accounting: Accrual accounting is a method of accounting where revenue and expenses are recorded when they are earned or incurred, rather than when cash is received or paid.

Unearned Revenue: Unearned revenue is the same as deferred revenue, representing payments received by a company for products or services that have not yet been delivered or performed.

Cash Basis Accounting: Cash basis accounting is a method of accounting where revenue and expenses are recorded when cash is received or paid, rather than when they are earned or incurred.