The key difference lies in the perspective and the transaction’s nature. Deferred payment is from the buyer’s viewpoint—it’s about delaying the payment for goods or services. On the other hand, deferred revenue is from the seller’s perspective—it involves receiving payment for goods or services that will be delivered or performed in the future.

Revenue and expense deferrals can significantly impact the financial statements, which are then used by the internal management and external stakeholders to make important business decisions. Deferral is also used to describe the type of adjusting entries used to defer amounts at the end of an accounting period. The “Deferred Revenue” line item depicts the unearned revenue that will be reported in a later period.

• In other words, it is paid for goods or services not yet given or obtained by them.
• On the other hand, revenue deferrals account for a product or service contract that has been paid in advance.
• The payment is considered a liability to the company because there is still the possibility that the good or service may not be delivered, or the buyer might cancel the order.
• Every month, the entire payment is recognized on the statement of income until it is ‘used up.’ Such a large expense cannot be accounted for in a single-monthly accounting report since it won’t then match the income.
• In the same way, a firm’s accountant should ensure that the expenses paid in advance of receiving the product or service should be deferred.

In a way, this is the opposite of deferred revenue, which records revenue for services or products yet to be delivered. Accrual accounting records revenue for payments that have not yet been received for products or services already delivered. Deferred revenue is typically reported as a current liability on a company’s balance sheet, as prepayment terms are typically for 12 months or less. Accrual accounting recognizes revenues and expenses as they’re earned or incurred, regardless of when the actual cash is exchanged.

The other company involved in a prepayment situation would record their advance cash outlay as a prepaid expense, an asset account, on their balance sheet. The other company recognizes their prepaid amount as an expense over time at the same rate as the first company recognizes earned revenue. A deferral of revenues or a revenue deferral involves money that was received in advance of earning it.

Deferred revenue

The money received from the subscription payments does not technically count as revenue until the service is performed. At the end of each month, a portion of the subscription payment is recorded as income. Over time, the entire subscription payment will be recognized as revenue.

• Accuracy is key in record keeping, but it doesn’t have to be complicated.
• A deferral relates to a financial transaction amount paid or received, while the related service has not yet been performed or received.
• The deferred revenue is gradually booked so that by the end of the current period, the balance of the deferred revenue account is $0.

An example is the insurance business that will collect money for insurance protection for the next six months in December. The insurance company should disclose the outstanding balance as a current liability, for instance, Unpaid Insurance premiums, before the amount is earned. For insurance premiums earned, the statement of income should be stated as Insurance Premium Revenues.

Revenue recognition is usually done when a crucial event occurs and the company can easily measure the dollar amount. This time we’ll look at one of the magazine subscriptions that Anderson Autos paid for. The magazine is called “Film Reel” and it is a national entertainment magazine. It focuses on content related to movies that are about to be released into cinemas. This last section here provides some general guidelines you can follow to make recording these transactions easy. For understanding how the deferrals are calculated, we shall see some examples in the next sections.

What Deferred Revenue Is in Accounting, and Why It’s a Liability

The insurance company receiving the $12,000 for the six-month insurance premium beginning December 1 should report $2,000 as insurance premium revenues on its December income statement. The remaining $10,000 should be deferred to a balance sheet liability account, such as Unearned Premium Revenues. In each subsequent month the insurance company will record an adjusting entry to reduce the liability account Unearned Premium Revenues by $2,000 and report $2,000 as Premium Revenues on its income statement. A property owner receives the annual rent for a future fiscal period in advance. The capital in the cash account and the liability account will increase at the time of the payment. It will slowly be recognized as earned revenue so that eventually, by the end of the year, the liability account will be empty.

AccountingTools

The purpose of an accounting deferral is to match the revenue or expense to the period the service is performed. Business owners may need to record a deferral transaction whenever a portion of revenue or expense should be applied at a later date. Having received the payment, the company is set to deliver the equipment between January 1 and February 27. The customers will pay the remaining or balance amount once they receive their deliveries. Till this is done, the company will write this amount (that is payable) as deferred revenue in the balance sheet. In other words, it is an amount received or paid before the delivery of actual services or products.

How Do You Record Deferred Revenue in an Account?

Suppose a company decided to receive a payment in advance for a year-long subscription service. For instance, when you sell your services to the client a month or so in advance, you will not immediately count that sale as earned revenue, being that you have not yet earned it (provided the accounting for consignment service). To keep things simple, a deferral refers to any money that you paid or received before the performance of a service. To break it down further, if you paid in advance for a service, or someone else paid you for a service that you haven’t yet received, then a deferral is in play.

This means paying for a service or product which hasn’t been received yet or getting paid for an item which has not been delivered as yet. Deferral permits reflecting of expenses or revenues later on in the financial statements when the product or service has been delivered. For example, ABC International receives a $10,000 advance payment from a customer.

Film Reel’s accounting department cannot still add $602 to the income statement sales revenues. This cannot be achieved because the magazines have not been produced, so it is impossible to add the cost of the goods sold (the costs involved with production). However, it’s crucial to distinguish deferred payment from deferred revenue.

To summarize, deferrals move the recognition of a transaction to a future period, while accruals record future transactions in the current period. The recognition of accrual and deferral accounts are two core concepts in accrual accounting that are both related to timing discrepancies between cash flow basis accounting and accrual accounting. Debits and credits are used in a company’s bookkeeping in order for its books to balance.

Why defer expenses and revenue?

Assume that a company with an accounting year ending on December 31 pays a six-month insurance premium of $12,000 on December 1 with insurance coverage beginning on December 1. One-sixth of the $12,000, or $2,000, should be reported as insurance expense on the December income statement. The remaining $10,000 is deferred by reporting it as a current asset such as prepaid insurance, on its December 31 balance sheet. For example, a company receives an annual software license fee paid out by a customer upfront on the January 1.