How to post a deferred revenue journal entry

Posting a deferred revenue journal entry starts with recording the payment as a liability in your deferred revenue account. Over time, as you deliver goods or services, you'll adjust the entry to recognize the revenue properly.

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This process is especially important for businesses like SaaS companies or real estate firms that often receive payments in advance. These companies must record deferred revenue journal entries to ensure compliance with accounting standards and provide a transparent view of the company’s financial health.

What is deferred revenue?

Deferred revenue, also known as unearned revenue, is cash received from a customer for a product or service that will be delivered in the future. If the product or service is not delivered, funds must be returned to the customer. As a result, the deferred revenue balance is a liability on the balance sheet.

In accrual accounting, prepaid funds increase cash flow but are not recognized as revenue on the income statement until the goods or services are delivered.

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Accrual basis vs. cash basis accounting

Your chosen accounting method — accrual and cash-basis accounting — determines how and when you record journal entries. Deferred revenue aligns with the accrual method, which ensures revenue is matched with the delivery of goods or services rather than with cash inflows.

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Businesses that use the accrual basis of accounting may post journal entries to deferred revenue.

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Accrual basis accounting conforms with the matching principle, which posts revenue when earned and expenses when incurred to generate revenue. The accrual method does not post revenue based on cash inflows and outflows.

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Generally Accepted Accounting Principles (GAAP) require businesses to use accrual accounting because it presents a more accurate picture of company profitability.

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Cash-basis accounting, on the other hand, posts revenue when cash is received and expenses when cash is paid. This method does not match revenue with expenses, which can make financial reporting less accurate. As businesses grow, they should transition to accrual accounting for better financial tracking.

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Cash-basis accounting often posts revenue in a different accounting period than the accrual method. For example, if a customer sends a $450 advance payment for three months of subscription fees on August 1st, the cash-basis method would record $450 in revenue on August 1st. However, under the accrual method, the $450 is treated as unearned income and recorded as a current liability until the services are provided.

Revenue recognition principle

The revenue recognition principle, a core element of GAAP, states that revenue should only be recorded when:

1. The product or service is delivered.
2. Payment is reasonably assured.
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Assume, for example, that a supplier sells $20,000 worth of lumber to a furniture manufacturer on credit. The supplier debits (increases) accounts receivable by $20,000 and credits (increases) revenue by $20,000.

Weeks later, the supplier was notified that the manufacturer had filed for bankruptcy. There is no longer a reasonable expectation of payment, and the accounts receivable and revenue accounts are reduced by $20,000 in the accounting system.

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A business may receive rent payments or subscription payments in advance. These payments increase the deferred revenue account.

Examples of deferred revenue journal entries

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Your deferred revenue accounts track various types of advance payments - from annual software subscriptions and retainer fees to maintenance contracts, airline tickets, course tuition, and prepaid rent. While these payments boost your cash flow statement immediately, they remain as deferred income until you deliver the service. Let's explore two common scenarios in detail to understand the specific journal entries required:

Rent revenue example

Rental agreements often require the tenants to pay rent in advance. For example, assume a commercial real estate company requires a new business tenant to pay the first and last month's rent when the rental agreement is signed. The monthly rental payment is $5,000, and the tenant pays $10,000.

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The owner earns revenue over time, like interest on a bank balance. As time passes, the owner earns more revenue.

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The real estate company increases cash with a $10,000 debit, and deferred revenue is credited (increased) by $10,000. At the end of the first month, the real estate company debits (decreases) deferred revenue by $5,000 and credits rent revenue for $5,000. The other $5,000 is reclassified from deferred revenue to rent revenue at the end of the last month of the agreement.

Subscription revenue

Many SaaS software companies charge subscription fees, and fees paid in advance generate deferred revenue.

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If a customer pays $300 in advance for three months of subscription fees, the business debits cash and credits deferred revenue. At the end of month one, $100 is reclassified from deferred revenue into the subscription revenue account. The same journal entry is posted at the end of months two and three.

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The business's financial health is misleading if the cash-basis method is used. If the seller doesn’t provide a product or service, customer payments must be returned. The accrual method posts the payments to a liability account.

Deferred revenue management challenges

Accounting for deferred revenue presents several bookkeeping challenges:

• Different types of journal entries: The accounting staff posts deferred revenue when cash is received and moves the balance into the revenue account when revenue is earned. If the customer pays cash upfront and delivers a product or service immediately, only one journal entry is posted to increase cash and record revenue.

• Timing issues: Your team must carefully monitor when to move payments from deferred revenue into earned revenue. This becomes particularly complex with varying contract start dates, service delivery schedules, and subscription periods.

• Multiple payment methods: Each payment type - checks, ACH transfers, and credit cards - has different processing times and reconciliation needs. This affects when you record the initial deferred revenue entry and impacts cash flow tracking.

• Subscription plan changes: When customers upgrade, downgrade, or cancel their subscriptions, your team must accurately adjust deferred revenue balances, prorate remaining service periods, and update future revenue recognition schedules. This often requires complex calculations to ensure both your revenue recognition and refund obligations remain accurate.

• Customer account changes: Business changes among your customers can significantly impact deferred revenue tracking. When clients go through mergers, acquisitions, or restructuring, you must update billing contacts, payment methods, and contract terms.
  You need processes and tools to properly account for deferred revenue. If not, your financial statements will not be accurate, and you will lose the confidence of stakeholders. Here are some strategies for improving deferred revenue accounting.

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How to simplify deferred revenue management

You can simplify deferred revenue management using accounting software and a detailed procedures manual.

Take advantage of accounting software

Accounting software, especially those with intelligent automation, can streamline deferred revenue management by minimizing errors and saving time.

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To illustrate, assume you operate a SaaS business that generates subscription revenue. Premier Supply sends you a $300 ACH payment on March 1st for three months of subscription fees, instead of their usual $100 monthly payment.

When the $300 payment is received, AI-powered software immediately:

• Identifies the payment and matches it to Premier Supply's account
• Flags the payment amount variance
• Creates appropriate journal entries
• Sets up automatic revenue recognition schedules

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The system then automates two key journal entries:

• March 1st: Debit cash $300, credit deferred revenue $300 to recognize the $300 prepayment of subscription fees.
• March 31st: Debit deferred revenue $100, credit revenue $100 to record March subscription fee revenue.
  
  

The software continues tracking the remaining balance, automatically recognizing $100 in revenue on April 30th and May 31st. This automation eliminates manual tracking and reduces the risk of missed entries or timing errors that often occur with spreadsheet-based systems.

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Create deferred revenue procedures

Your business should create written procedures for each routine accounting task, including payroll, billing, accounts receivable, and accounts payable. The manual can include instructions for unusual transactions, including deferred revenue.

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The procedures manual documents who completes each task and how often. When you train a backup for each task, add that individual to the manual. A procedures manual eliminates confusion about accounting tasks and serves as a training tool for your team. When a new team member has to post deferred revenue entries, they can refer to the manual.

You may have to account for thousands of transactions as your business grows, so using automation alongside a procedures manual helps you save time and reduce errors.

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Automating your deferred revenue workflow  

Accounting software can handle many manual deferred revenue tasks, from scanning transactions and posting journal entries to simplifying account reconciliation and reducing monthly close time. Implementing the right automation tools allows your accounting team to focus on more strategic work.

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Some features you should look for include automatic transaction categorization, journal entry generation based on predefined rules, revenue recognition schedule tracking, and anomaly detection for unusual transactions. The system should also integrate smoothly with your existing accounting systems to prevent data silos or reconciliation issues.

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Ramp helps finance teams manage these processes efficiently by automatically collecting receipts, ensuring consistent expense categorization, and flagging potential issues before they impact financial statements. The software automates expense management, accounts payable, procurement, and travel to help you save time on repetitive tasks and scale your business with a smaller staff.

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30,000+ finance teams have saved millions of hours with Ramp. Explore how Ramp customers save an average of 5% a year across all spending.

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