Deferred revenue is revenue that has been received by a company but not yet earned. This usually happens when a company provides a service or sells a product but does not officially bill the customer for the full amount. The customer pays in advance, and the company recognizes the revenue only when it delivers the service or product. Deferred revenue is also called unearned revenue or unearned income.
Deferred revenue is recognized as income when it is earned, which is usually when the company provides the service or product. For example, if a company sells a one-year subscription to a software service for $120, it will recognize $10 of deferred revenue each month as the service is provided.
Recognizing deferred revenue has two main implications. First, it means that the company has a liability on its balance sheet for the amount of deferred revenue. This is because the company has received the money but has not yet earned it. Second, it means that the company will recognize income in future periods when it earns the revenue, rather than in the period when it receives the money.
Deferred revenue is reported as a liability on the balance sheet. The amount of deferred revenue is equal to the amount of revenue that has been received but not yet earned. For example, if a company has received $120 in advance for a one-year subscription to a software service, the deferred revenue would be reported as a $120 liability on the balance sheet.
There are a few challenges that can arise when accounting for deferred revenue. First, it can be difficult to estimate the amount of revenue that will be earned in future periods. This is because the company may not know how many customers will use the service or how long they will use it for. Second, deferred revenue can create a discrepancy between the time when the company receives the money and when it recognizes the income. This can make it difficult to compare the company's financial statements from one period to another.
There are a few best practices that companies can follow to ensure that their accounting for deferred revenue is accurate and up to date. First, companies should have a clear and consistent policy for recognizing deferred revenue. This will help ensure that all revenue is recognized in the correct period. Second, companies should regularly review their deferred revenue balances to ensure that they are accurate. This can be done by comparing the amount of deferred revenue to the amount of revenue that has been invoiced but not yet earned. Finally, companies should disclose their deferred revenue balances in their financial statements. This will allow investors and other interested parties to see how much revenue has been received but not yet earned.