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What is Deferred Revenue and Why is it a Liability?
Whether you’re a small business owner or an investor researching stocks, understanding deferred revenue and why it’s considered a liability is essential. Deferred revenue is income that has been collected but has not been earned yet – it can also be considered “unearned” income. When this income is received, it is recorded, and must then be recognized in the accounting period. In this blog post, we will look at what is deferred revenue, why it’s a liability, and how you can track it.
What is Deferred Revenue?
Deferred Revenue, also known as Unearned Revenues, is income received from customers in exchange for goods or services that have not yet been delivered. It is recorded when an invoice is generated and the customer pays for the goods in advance. The income is then recorded as a liability and listed on the balance sheet, as the company has yet to provide the goods or services to the customer.
Deferred revenue can be found on balance sheets as Accounts Receivable or other assets depending on the type of business. It is important to note that Deferred Revenue is not to be confused with Account Receivable. Deferred Revenue is money that has been received in advance for goods or services that have not yet been provided, whereas Accounts Receivable is money that has been owed but has not yet been paid.
Why is Deferred Revenue Considered a Liability?
Deferred revenue is considered a liability because the company hasn’t yet provided the goods or services it was paid for. In accounting terms, a liability is an obligation to provide something, so this means that deferred revenue is an obligation to provide something that has not yet been provided. The company is still responsible for providing the goods or services it received the payment for, and therefore, it is listed on the balance sheet as a liability.
Importance of Tracking Deferred Revenue
Tracking deferred revenue is important because it allows companies to accurately assess how much cash flow is coming in and how much has been paid in advance. This information can be used to make better decisions regarding budgeting, purchasing, and pricing. On the balance sheet, deferred revenue can help investors assess the overall health of a company’s financial performance. This is because it gives an idea of how strongly the company is performing over time.
When to Report Deferred Revenue
To properly record deferred revenue, it should be reported on the company’s balance sheet at the time of the initial receipt of payment. This will account for the income that was generated from the sale. The revenue is then recognized, or reported, in the accounting period when the goods or services are actually provided to the customer. This helps ensure that companies recognize revenue when it is earned, rather than when it is received.
How to Calculate Deferred Revenue
Calculating deferred revenue is done by taking the actual income that was received for a sale of goods/services, and subtracting expenses or returns associated with that sale. This calculation will show how much deferred revenue is available to be recognized when the goods or services have been provided to the customer.
Conclusion
Deferred revenue is income that has been collected but not earned yet. It is treated as a liability because the company is still responsible for providing the goods or services it received the payment for. It is important to track deferred revenue as it allows companies to make better decisions regarding budgeting, purchasing, and pricing. To properly record deferred revenue, it should be reported on the company’s balance sheet at the time of the initial receipt of payment and then recognized in the accounting period when the goods or services are actually provided. Calculating deferred revenue can be done by taking the income that was received for a sale of goods/services, and subtracting the associated expenses and returns.
FAQs
Q: What is deferred revenue?
A:Deferred revenue is income that has been collected but has not been earned yet – it can also be considered “unearned” income. When this income is received, it is recorded, and must then be recognized in the accounting period.
Q: Why is deferred revenue considered a liability?
A: Deferred revenue is considered a liability because the company hasn’t yet provided the goods or services it was paid for. In accounting terms, a liability is an obligation to provide something, so this means that deferred revenue is an obligation to provide something that has not yet been provided.
Q: What is the importance of tracking deferred revenue?
A: Tracking deferred revenue is important because it allows companies to accurately assess how much cash flow is coming in and how much has been paid in advance. This information can be used to make better decisions regarding budgeting, purchasing, and pricing.
Q: When should deferred revenue be reported?
A: To properly record deferred revenue, it should be reported on the company’s balance sheet at the time of the initial receipt of payment. This will account for the income that was generated from the sale. The revenue is then recognized, or reported, in the accounting period when the goods or services are actually provided to the customer.
Q: How is deferred revenue calculated?
A: Calculating deferred revenue is done by taking the actual income that was received for a sale of goods/services, and subtracting expenses or returns associated with that sale. This calculation will show how much deferred revenue is available to be recognized when the goods or services have been provided to the customer.
Q: What is the difference between deferred revenue and accounts receivable?
A: Deferred Revenue is money that has been received in advance for goods or services that have not yet been provided, whereas Accounts Receivable is money that has been owed but has not yet been paid.