How to record deferred revenue

Introduction

In business, we may receive cash in advance from our customers for the service that we will perform in the near future. In this case, we need to record this cash received in advance as the deferred revenue to represent the liability that we owe to the customer.

This is to comply with the accrual basis of accounting in which we can only record the revenue when it is earned. And as cash received in advance is not earned yet, the revenue will need to be deferred to a further date and can only be recorded as revenue when it is earned.

Likewise, later on, when we earn that revenue we can transfer the deferred revenue to the revenue. This is when we can eliminate (or reduce) the deferred revenue for the reason that we have fulfilled the obligation (or part of obligation) that we have owed to the customer.

How to record deferred revenue

We can record the deferred revenue with the journal entry of debiting the cash account and crediting the deferred revenue account.

In this journal entry, we record the deferred revenue as a liability on the balance sheet as it represents the obligation that we owe to our customers.

Likewise, this deferred revenue can be transferred to the revenue when we have fulfilled the obligation that we owe to customers. This can be done by debiting the deferred revenue account and crediting the revenue account as in the journal entry below:

This journal entry will eliminate (or reduce) the deferred revenue that we have recorded above.

Deferred revenue example

For example, on December 31, we receive a $1,000 cash in advance from our customer for the service that we will perform in the next month of January. As we receive this $1,000 before performing any service for our customer, this $1,000 represents the obligation that we need to fulfill in January.

Likewise, we need to record this $1,000 as a deferred revenue which is a liability, on December 31, in the journal entry of deferred revenue below:

December 31:

In this journal entry, both total assets and total liabilities on the balance sheet will increase by $1,000 as of December 31.

Later, after performing the service that we owed to the customer for this $1,000, we can record the revenue that we have earned by transferring this $1,000 amount from deferred revenue to revenue as in the journal entry below:

Likewise, this journal entry will increase total revenues on the income statement by $1,000 while decreasing total liabilities on the balance sheet by the same amount of $1,000.