Deferred revenue is a payment from a customer for future goods or services. The seller records this payment as a liability, because it has not yet been earned. Deferred revenue is common among software and insurance providers, who require up-front payments in exchange for service periods that may last for many months.
Deferred Revenue Recognition
As the recipient earns revenue over time, it reduces the balance in the deferred revenue account (with a debit) and increases the balance in the revenue account (with a credit). Depending on the contract terms, the selling entity may not be allowed to recognize revenue until all goods have been delivered and/or services completed; this can skew the reported performance of a business to show early losses, followed by profits in later periods.
The deferred revenue account is normally classified as a current liability on the balance sheet. It can be classified as a long-term liability if performance is not expected within the next 12 months.
Deferred Revenue Accounting
For example, Alpha Corporation hires Northern Plowing to plow its parking lot, and pays $5,000 in advance, so that Northern will give the company first plowing priority throughout the winter months. At the time of payment, Northern has not yet earned the revenue, so it records all $5,000 in a deferred revenue account, using this deferred revenue journal entry:
|Deferred revenue (liability)||5,000|
Northern expects to be plowing for Alpha for a period of five months, so it elects to recognize $1,000 of the deferred revenue per month in each of the five months. For example, in the first of the five months, Northern records the following entry:
|Deferred revenue (liability)||1,000|
|Plowing revenue (revenue)||1,000|