Deferred revenue, also known as unearned revenue or deferred income, represents money that a company has received in advance for goods or services that it has not yet delivered. It’s a liability on the balance sheet because the company still owes the customer the product or service for which it has been paid.
Here’s a breakdown of how deferred revenue works:
- Customer Payment: The company receives payment from a customer before delivering the goods or services.
- Recognition as a Liability: The amount received is recorded as a liability on the balance sheet under deferred revenue. This indicates that the company has an obligation to fulfill in the future.
- Recognition as Revenue: As the company delivers the goods or services, it gradually recognizes the deferred revenue as revenue on the income statement. The amount recognized as revenue corresponds to the portion of the obligation that has been fulfilled.
This accounting treatment is common in subscription-based businesses, software companies, and other industries where customers pay in advance for services they will receive over time.
For example, if a software company sells an annual subscription for $1,200, it would recognize $100 of deferred revenue each month as it fulfills its obligation to provide the software service.
Deferred revenue is crucial for understanding a company’s financial health and its ability to meet future obligations. It’s a liability until the goods or services are delivered, at which point it becomes recognized as revenue.