Deferred revenue is money your business has received for a product or service you haven’t delivered yet.
So what does this actually mean?
Also referred to as unearned revenue, this shows as a liability on your balance sheet because, from an accounting perspective, you still owe the customer what they paid for. Once you deliver the product or render the service, that deferred revenue transforms into earned revenue.
- Earned revenue. Earned revenue is income your company officially recognizes in its books after delivering goods or providing services to customers. It reflects the value of work you’ve actually completed and is therefore no longer a liability.
- Accounts receivable. This is money still owed to your business for goods or services you’ve already delivered but haven’t been paid for.
Step by step
Here’s how deferred revenue works in practice:
- Your customer pays for something in advance.
- Your business records the customer’s payment as a liability because you still need to fulfill the customer’s order. If you’re unable to do that, you must return the payment to the customer.
- You deliver to the customer and because you have fulfilled your obligation, you no longer have a liability.
Annual software licenses and prepaid maintenance contracts are good examples of deferred revenue. Customers pay in advance, but you, the business, only recognize that revenue once you provide ongoing software access or perform the maintenance service. Ever pay in advance for a concert ticket? It’s deferred revenue on the venue’s books until the event takes place.
These scenarios highlight why deferred revenue is a common concept in accounting. Correctly categorizing deferred revenue keeps your books accurate.
Accounting treatment
If you expect to satisfy your obligation within the next year, deferred revenue appears under current liabilities on your balance sheet. This classification signals that your company has received payment up front but still needs to fulfill its promise in the short term, making the liability “current” instead of long-term.
What if you don’t anticipate delivering a product or rendering a service within the year? If any portion of deferred revenue relates to obligations that will be met beyond a year, it’s placed under non-current liabilities on your balance sheet. This helps stakeholders see how soon commitments must be delivered.
Once you have met your obligations, you no longer have to classify deferred revenue as a liability—it’s now earned revenue.
This accounting treatment of deferred revenue complies with International Financial Reporting Standards and the U.S.’s Generally Accepted Accounting Principles (GAAP).
Why does deferred revenue matter?
It’s the backbone of honest accounting
Accounting for deferred revenue (literally) makes sure that your financial reports truly reflect what’s been earned, not just what’s been collected in cash. In the world of accounting, getting paid is not the same thing as having earned.
By treating upfront payments as liabilities until you deliver the promised service or product, deferred revenue prevents income from being overstated and avoids giving a false impression of profitability.
That said, deferred revenue can be a helpful tool for understanding how a company may perform in the future.
It represents cash that must be managed wisely
Customers’ payments must cover future expenses, support operations, and maintain a healthy buffer for upcoming costs. If you pay attention to your deferred revenue, you can better allocate resources where they’re needed.
It’s critical for transparency and audit readiness
Want stakeholders to understand how your business is doing? Make sure you’re tracking deferred revenue. Accurate tracking ensures your financial reports show the status of monies in—i.e., what’s just been collected up front vs. what’s been earned—so you avoid overstating revenue and follow IFRS (and GAAP, if you’re in the U.S.).
This meticulous recordkeeping is essential if an audit occurs. Auditors need documentation that deferred revenue was properly recorded and recognized correctly as such. Staying audit-ready ensures your company is poised to pass review and builds trust with all stakeholders, from investors to employees.
Risks and considerations
Failing to recognize or track deferred revenue correctly
Suppose your business fails to correctly recognize deferred revenue (whether by classifying it as earned too early or failing to track it accurately). In that case, you risk creating distorted financial statements that could mislead stakeholders.
These mistakes (intentional or not) run afoul of IFRS and GAAP standards, potentially resulting in fines, regulatory investigations, and damage to your company’s reputation. In particular, potential and current investors may no longer trust your financial statements to reflect the reality of your business.
Cashflow problems
A risk with deferred revenue is a business relying too much on these upfront payments while lacking the capacity or resources to deliver the promised products or services—this spells trouble.
Remember that while deferred revenue boosts cash flow in the short term, that cash is essentially “spoken for.” Using it for unrelated expenses before fulfilling customer commitments may leave you short when it’s time to deliver. Overreliance on deferred revenue without a solid plan for delivery can put your operations at risk and jeopardize your ability to meet future costs.
How can Pebl power your payroll?
Keeping on top of accounting is difficult enough when you’re dealing with one location and one currency—but today’s successful business go global, and that means compounding complexity when it comes to payroll.
So let Pebl help.
With our employer of record services, we centralize your payroll and accounting across 185+ countries worldwide, whether you have one location or a dozen. With deeply integrated AI, you and your team get near real-time results and we catch compliance issues before they happen, not after.
When you’re ready for expert help, contact us.
This information does not, and is not intended to, constitute legal or tax advice and is for general informational purposes only. The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. The content in this guide is provided “as is,” and no representations are made that the content is error-free.
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