How to Find and Calculate Deferred Revenue

Deferred revenue is a fundamental concept in accrual accounting, representing payments a business receives for goods or services it has not yet provided. When a customer pays in advance, the company cannot immediately count that money as earned income. Instead, this prepayment is recorded as a liability, signifying an obligation to the customer. This method aligns with the revenue recognition principle, a core component of U.S. Generally Accepted Accounting Principles (GAAP), which dictates that revenue should only be recognized when it is earned.

Sources of Deferred Revenue

Common business transactions generate deferred revenue, such as in the software-as-a-service (SaaS) industry where customers often pay an annual subscription fee upfront. The company receives the full payment at the beginning of the term but must recognize this revenue on a monthly basis over the course of the year as the service is delivered.

Gift cards and store credits are another source. When a customer purchases a gift card, the business receives cash but has not yet provided any goods or services. The value of the gift card is recorded as a liability. Only when the customer redeems the card for merchandise does the company recognize the corresponding amount as revenue.

Professional service firms, like legal or consulting practices, often use retainer fees paid in advance. The revenue is deferred and then recognized as the services are rendered over time. Advance payments for custom projects or pre-paid memberships for gyms or publications are also treated as deferred revenue until the service is provided.

Locating Deferred Revenue on the Balance Sheet

Deferred revenue is reported as a liability on a company’s balance sheet because the advance payment represents a duty to deliver products or perform services in the future. The classification depends on when the company expects to earn the revenue. If the goods or services are expected to be delivered within one year, the amount is classified as a current liability. For obligations that extend beyond a twelve-month period, that portion is categorized as a non-current or long-term liability. Public companies typically report these figures in their annual 10-K filings with the U.S. Securities and Exchange Commission (SEC).

The line item may not always be labeled “Deferred Revenue” on a balance sheet. Alternative titles include “Unearned Revenue,” “Customer Deposits,” or “Contract Liabilities.” The specific terminology can vary by industry and company preference, but the underlying accounting treatment remains the same.

Calculating Deferred Revenue

Calculating the ending deferred revenue balance for an accounting period requires three pieces of information. These are the beginning deferred revenue balance from the previous period, all cash payments received in advance during the current period, and a record of which revenue was earned during the current period.

The calculation uses the formula: Ending Deferred Revenue = Beginning Deferred Revenue + Cash Received in Advance – Revenue Earned. The balance increases with new advance payments from customers and decreases as the company delivers on its promises and recognizes the revenue.

Consider a company that sells a one-year software subscription on January 1st for a single upfront payment of $1,200. Initially, the company records the $1,200 as a debit to Cash and a credit to Deferred Revenue. Each month, one-twelfth of the service is fulfilled, so the company earns $100 ($1,200 / 12 months). To reflect this, a journal entry is made to debit Deferred Revenue for $100 and credit Service Revenue for $100. This monthly entry systematically reduces the deferred revenue liability on the balance sheet and increases the recognized revenue on the income statement, ensuring financial statements accurately reflect the company’s performance over time.