Sometimes our revenue may not be tangible, leading to a false impression of our business’ financial health. In the Software-as-a-Service (SaaS) industry, deferred revenue is common practice—monthly and annual subscription payments are usually collected upfront to guarantee future income. Deferred revenue is classified as a liability, in part, to make sure your financial records don’t overstate the value of your business. A SaaS (software as a service) business that collects an annual subscription fee up front hasn’t done the hard work of retaining that business all year round. Classifying that upfront subscription revenue as “deferred” helps keep businesses honest about how much they’re really worth.

Unless your Professional Services Firm strictly contracts on time and materials, you may need to account for deferred revenue. If you bill for a project, and have yet to fully complete the work, you have deferred revenue. If your firm uses pre-payments, managed services, subscriptions and even fix-fee and milestone invoicing, you may have to account for deferred revenue and ensure you are ASC 606 compliant. Overall, by properly accounting for deferred revenue, analysts can gain a better understanding of a company’s future revenue potential and its ability to generate cash over time. For the first month, you recognize $1500 and defer the remaining $16500 to an adjustment account. For each month after that, you’ll credit the deferred revenue account and debit the sales account $1500.

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In this transaction, the Prepaid Rent (Asset account) is increasing, and Cash (Asset account) is decreasing. Of course, for smaller, privately-owned businesses, there are no current regulations to meet these GAAP standards. While GAAP practices are a requirement for any publicly traded company, they’re considered best practices for private companies as well. Employing consistent, industry-accepted best practices for your bookkeeping efforts can deliver clearer insight into your company and help avoid a number of headaches. In this image, there is an invoicing schedule with one record, and a revenue recognition schedule with a record for each month of revenue recognition over the term. As part of their digital transformation, many companies use revenue recognition automation technology to streamline their accounting processes.

Instead, they commonly ignore any accrued revenue while tracking deferred revenue the same as any other payment. At the end of the accounting period, however, the relevant accounting department will create adjusted journal entries as part of the closing process. The opposite of deferred revenue is accrued revenue (i.e., revenue recognized before cash is received). law firm bookkeeping The difference between the two is that deferred revenue is money a company receives before goods or services are delivered, while accrued revenue is money a company receives after goods or services are delivered. If a company uses the cash accounting method, then deferred revenue is irrelevant — the company pays income taxes as it receives payments no matter what.

How to account for deferred revenue

Under the cash basis of accounting, deferred revenue and expenses are not recorded because income and expenses are recorded as the cash comes in or goes out. This makes the accounting easier, but isn’t so great for matching income and expenses. Learn more about choosing the accrual vs. cash basis method for income and expenses. No, in cash basis accounting revenue is reported only after it has been received. As well, expenses in cash basis accounting are recorded only when they are paid. No matter the strategy, accurately capturing both accrued and deferred revenues can at times be complicated—particularly when dealing with any delinquent payments.

Deferred revenue is the revenue you expect from a booking, but you are yet to deliver on the account’s agreement. Thus, even though you received the revenue in your account, you cannot quite count it as revenue. Whereas recognized revenue refers to the point at which a booking or deferred revenue becomes actual revenue for your business after delivering on the agreement as promised. For example, when a SaaS company https://www.digitalconnectmag.com/a-deep-dive-into-law-firm-bookkeeping/ charges a new client a $180 annual subscription fee, it does not immediately record the fee as actual revenue in its books. Instead, it will record it as deferred revenue first in its balance sheet and only record the $180 in revenue at the end of the year after earning the entire fee. Deferred expenses, similar to prepaid expenses, refer to expenses that have been paid but not yet incurred by the business.

Is deferred revenue a debit or credit in accounting?

Often seen in subscription-based businesses and online services, deferred revenue is income collected before the service is provided. To protect their interests, many companies require their customers and clients to pay upfront for products or services before they are delivered. Although it’s a liability, having a deferred revenue balance on your books isn’t necessarily a bad thing.

An example of unearned revenue could be a magazine publisher that offers annual subscriptions. If a customer pays for a one-year subscription upfront, the publisher would recognize the payment as unearned income. The publisher has an obligation to provide the customer with a magazine each month for the duration of the subscription period. Deferred revenue and accrued expenses both appear under liabilities on a company’s balance sheet. While deferred revenue refers to money that the business has received in advance of providing goods and services, accrued expenses are money the business owes for goods and services it has already received.

Conclusion: The importance of understanding deferred revenue for business success

On August 1, the company would record a revenue of $0 on the income statement. On the balance sheet, cash would increase by $1,200, and a liability called deferred revenue of $1,200 would be created. However, if the business model requires customers to make payments in advance for several years, the portion to be delivered beyond the initial twelve months is categorized as a “non-current” liability. Imagine a SaaS company offers a monthly plan with $10 payments and a discounted yearly plan of 99.99 to attract customers. The company will defer the revenue from customers who opt to pay in advance for the annual subscription to enjoy the discount and recognize it monthly as per the customers’ use of the service.