Deferred Revenue | Unearned Revenue
Deferred revenue refers to the accounting treatment of advance payments a company receives for products or services that are to be delivered or performed in the future. The company that receives the prepayment records the amount as deferred revenue, a liability, on its balance sheet.
Any receipt of payment before the delivery of products or services is called "deferred revenue". It is also known as "unearned revenue". The company receiving deferred revenue must first deliver the products or services for which it has already been paid and is liable to write off its products/services for the received amount.
Accounting Treatment of Deferred Revenue as a Liability
When the company receives the amount before the delivery of the goods or services, that amount is recorded as a liability on the balance sheet. It is an obligation for a company to deliver its goods/services. After the delivery of the goods/services, the liability becomes revenue. It is then recorded as revenue in the income statement.
Deferred revenue journal entry
To examine deferred revenue the following journal entry is recorded:
Increase in Deferred Revenue: Credit
Increase in Asset: Debit
Example:
On Jan 1st, ABC Consulting Group receives €20,000 from a customer for consulting work to be performed next month.
The above journal entry clearly suggests that the deferred revenue is a liability. As increase in liability is credit and decrease is debit. Therefore, the increase in deferred revenue is recorded as credit and decreases as a debit.
Recognition of Deferred Revenue
The recognition of deferred revenue reflects the fact that the services have now been delivered for which the company was paid.
Look into the journal entry given below:
Hence, the decrease in the deferred revenue is recorded as debit, while the earned revenue is recorded as a credit. While recognizing revenues, GAAP (Generally Accepted Accounting Principles) requires following the revenue recognition principle and matching principle. According to the revenue recognition principle, revenues should be recognized when earned, while the matching principle requires matching the associated costs with the revenues of the same accounting period.
To sum up, deferred revenue should initially be treated as a liability because it's an obligation for the company to provide goods or service for which they already have received the cash.
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