How to Account For Deferred Revenue

Deferred revenue is revenue that has been collected in advance but has not yet been earned. It is a liability on the company's balance sheet until the goods or services have been provided to the customer.

Here's how to account for deferred revenue:

1. Record the initial transaction: When you receive payment for goods or services that haven't been delivered yet, record it as deferred revenue in your balance sheet. This creates a liability that reduces your revenue and increases your liabilities.

2. Recognize the revenue: When you deliver the goods or services and fulfill the performance obligation, you need to recognize the revenue. You can do this either on a time basis or as milestones are met.

3. Reverse the deferred revenue: As you fulfill the performance obligation, you will reverse the deferred revenue balance on your balance sheet and record the corresponding revenue in your income statement.

For example, suppose a customer pays $12,000 upfront for a one-year software subscription, and you recognize revenue monthly. You would record the $12,000 as deferred revenue on your balance sheet and recognize $1,000 of revenue each month.

At the end of the year, the entire $12,000 will have been recognized as revenue, and the deferred revenue balance will be zero.

It's essential to manage deferred revenue carefully, as it can affect your financial statements, particularly your income statement, and your taxes.