Revenue Deferral Journal Entry: Deferred Income Accounting

Companies use a revenue deferral journal entry to record payments for products or services they haven’t yet delivered. They recognize revenue only when earned, following the accrual basis of accounting.

Deferred revenue appears as a liability on the balance sheet and it reflects the company’s obligation to provide goods or services in the future.

In this article, we will cover the following topics:

• The definition of deferred revenue.
• How deferred revenue works.
• Deferred revenue journal entries.
• The difference between deferred revenue journal entry and other entries.
• Considerations for tax compliance.
• Real examples.

Let’s get started with the definition.

What Deferred Revenue Is

Deferred revenue refers to payments a company receives in advance for goods or services it has yet to deliver.

This amount is recorded as a liability on the balance sheet since the company has an obligation to fulfill the order or service. The deferred revenue is then recognized as earned revenue when the company delivers the product or completes the service.

Deferred revenue is a liability because the company has a future obligation. The business cannot count the money as earned revenue until it fulfills its promise. The company gradually recognizes the revenue and reduces the liability as the product is delivered or the service is performed.

So, why use a revenue deferral journal entry in accounting?

Here are its importance:

• Deferred revenue helps create correct financial statements. It makes sure that income is recorded in the right time periods. This shows the company’s real financial performance.
• The proper management of deferred revenue makes sure compliance with accounting rules such as GAAP and IFRS.
• Companies show clear information to investors and others when they report deferred revenue accurately. This builds trust and helps them make decisions.

Anyway, let’s move on to the following section to see how it works.

How Deferred Revenue Works

It has two steps:

1. Receive the advance payment.
2. Deliver the obligation over time.
3. Completion of obligation.

Let’s take each one in-depth:

1- Receive the advance payment (deferred revenue)

A company can’t count an upfront payment as revenue right away when a customer pays for a product or service that will be delivered later.

Instead, the payment is listed as deferred revenue (a liability) on the balance sheet since the company still owes the customer the product or service.

Here is an example:

A software company receives $12,000 upfront for a one-year subscription and records the $12,000 as deferred revenue.

Here is the journal entry for this example:

Account                       Debit           Credit
-----------------------------------------------------------
Cash                          $12,000
Deferred Revenue                              $12,000

So here, the cash increases because the company receives payment, while the deferred revenue increases as a liability because the company owes the customer the subscription service.

2- Deliver the obligation over time

A company provides a product or service over time and starts with “deferred revenue,” which is money received in advance.

As the company fulfills its promise—like service delivery or a product bit by bit—it reduces this deferred revenue and records it as “earned revenue” in its financial reports.

This follows the rule that says revenue should only be counted when the company has done the work or delivered the product.

For example:

The company recognizes $1,000 per month as revenue ($12,000 ÷ 12 months) for the $12,000 one-year subscription.

Here is the journal entry:

Date       Account                Debit      Credit
---------------------------------------------------
XX/XX/XXXX Deferred Revenue       1,000
           Revenue                           1,000
(To recognize monthly earned revenue)

This repeats every month until all $12,000 is fully recognized as earned revenue by the end of the year.

3- Completion of obligation

The company fully delivers the product or service and completely recognizes the deferred revenue as earned revenue by the end of the subscription period. This reduces the deferred revenue liability to zero.

No final journal entry is needed here because the monthly entries already bring the deferred revenue balance to zero by the end of the period.

After 12 months of recognizing $1,000 each month, the deferred revenue will be fully used up. That leaves a balance of $0.

• Deferred revenue is $0.
• Revenue is $12,000 (fully recognized on the income statement).

Let’s see the difference between these two terms: deferred revenue and unearned revenue in the following section.

Deferred Revenue Vs. Unearned Revenue

Deferred revenue and unearned revenue both refer to funds a company receives before delivering goods or services. Companies record these payments as liabilities because they have yet to fulfill their obligations.

• Deferred revenue highlights that the company has delayed recognizing the revenue.
• Unearned revenue means that the company hasn’t earned the money yet because it hasn’t delivered the product or service.

The both terms mean the same thing. Companies use them to refer to payments they’ve received in advance for goods or services they haven’t given yet.

Anyway, let’s move on to the following section to compare it with the other term.

Deferred Revenue Journal Entry vs. Accounts Receivable

Deferred revenue and accounts receivable are both important accounting terms that represent amounts of money related to a company’s sales activities, but they reflect different financial situations.

So, the accounts receivable refers to money owed to a company by customers who have purchased goods or services on credit.

Here is the journal entry at sale:

Date       Account               Debit      Credit
---------------------------------------------------
MM/DD/YYYY Accounts Receivable    XXX
            Sales Revenue                     XXX
(To record sales made on credit)

The company recognizes revenue and records the amount owed by the customer as an asset when a sale is made on credit.

Here is the accounting entry at the time of payment:

Date       Account               Debit      Credit
---------------------------------------------------
MM/DD/YYYY Cash                  XXX
            Accounts Receivable             XXX
(To record payment received from customer)

While deferred revenue (also known as unearned revenue) represents money received by a company for goods or services not yet delivered or performed.

Here is the journal entry:

Date        Account               Debit      Credit
---------------------------------------------------
MM/DD/YYYY  Cash                   XXX
            Deferred Revenue                 XXX
(To record cash received in advance)

The company records it as a liability. It means an obligation to deliver in the future when payment is received before delivering the product or service.

Here is the revenue recognition with the journal entry:

Date        Account               Debit      Credit
---------------------------------------------------
xxxxxx      Deferred Revenue       XXX
            Sales Revenue                     XXX
(To recognize revenue as it is earned)

Here are the key differences:

• Revenue is recognized at the point of sale, even if payment is to be received later in accounts receivable.
• Payment is received before revenue is recognized because the service or product has yet to be delivered within the deferred revenue.
• The accounts receivable are listed as an asset, which reflects amounts owed to the company.
• The deferred revenue is listed as a liability. That reflects the company’s obligation to deliver goods or services in the future.

Let’s move on to the following part to see the compliance considerations for deferred revenue.

Tax and Compliance Considerations

The deferred revenue affects tax calculations. They can’t always report it as income right away for tax purposes when they receive money before delivering goods or services.

This means the company might need to adjust its tax reports to match when the service or product is delivered.

Some companies offer deferred compensation, where they promise to pay employees in the future. The IRS has rules (like section 409A) that make sure these payments are properly timed.

It might face extra taxes, such as a 20% penalty on the deferred amount if the company doesn’t follow the rules.

IFRS and GAAP say that deferred revenue should be listed as a liability until the company delivers the product or service. They accept that deferred revenue can be recognized as revenue once the company fulfills its obligations.

Let’s move on to the section below to understand the difference between deferred revenue and accrued revenue.

The Difference Between Deferred Revenue and Accrued Revenue

The deferred revenue and accrued revenue are two terms related to the timing of revenue recognition under accrual accounting principles.

Accrued revenue refers to income earned by a company for goods delivered or services performed that have not yet been billed or paid for by the customer.

While deferred revenue represents money received by a company for goods or services that have not yet been delivered or performed.

Accrued revenue is recorded as an asset (accounts receivable) on the balance sheet. The accounts receivable balance decreases, and cash increases once payment is received.

The deferred revenue allows the company to record it as a liability on the balance sheet. The liability decreases, and revenue is recognized in the income statement as the goods are delivered or services performed over time.

Let’s move on to the following section to real examples.

Examples

Example 1: Prepaid consulting service (in advance payment):

A consulting company receives $6,000 for a 6-month consulting contract. The company will provide consulting services over the next 6 months.

Journal Entry (on receiving payment):

Date        Account               Debit     Credit
---------------------------------------------------
01/01/2023  Cash                   6,000
            Deferred Revenue                  6,000
(To record payment received in advance for consulting services)

The company gets paid in advance but will complete the work over the next 6 months. So, it records the payment as “deferred revenue,”. That means the company still needs to provide the service to the client.

Journal entry (for each month of service delivery):

Date        Account               Debit     Credit
---------------------------------------------------
MM/DD/YYYY  Deferred Revenue       1,000
            Revenue                          1,000
(To recognize earned revenue for the month)

The company delivers part of the consulting service each month. It recognizes $1,000 as earned revenue each month. The deferred revenue liability decreases as the service is delivered.

Example 2: Event ticket sales (advance payment for future event):

A company sells tickets for a concert scheduled in 3 months. The company receives $15,000 in advance for 500 tickets at $30 each.

Date        Account               Debit     Credit
---------------------------------------------------
01/01/YYYY  Cash                   15,000
            Deferred Revenue                  15,000
(To record advance payment received for future concert event)

The company receives the payment in advance, but the event will take place in the future. Since the company has not yet delivered the concert, it records the $15,000 as deferred revenue (a liability) on the balance sheet.

Journal Entry (when the event happens and the revenue is earned):

Date        Account               Debit     Credit
---------------------------------------------------
04/01/YYYY  Deferred Revenue       15,000
            Revenue                          15,000
(To recognize revenue once the concert event has occurred)

Here, the company has fulfilled its obligation to the customers when the concert takes place. The entire $15,000 is recognized as earned revenue because the company has provided the concert service. So, the deferred revenue liability is reduced to zero.

Wrapping Up

In this article, we’ve covered what deferred revenue is and how to record it in journal entries.

Here is a quick recap:

• Deferred revenue happens when a company gets paid before it delivers a product or service.
• The payment is listed as a liability on the balance sheet since the company still needs to provide something to the customer.
• It records the payment as earned revenue as the company delivers the product or service.
• It also ensures they’re clear about what they’ve earned and what they still owe to customers.

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