Accrued revenue versus deferred revenue.
What are the similarities between accrued revenue and deferred revenue, and what are
the differences?
To start off with, both terms contain the word revenue.
One of the Big Questions in accounting is whether the delivery of goods or services
has occurred, or in more technical revenue recognition terms, whether the performance
obligations in the contract have been met.
There’s not always a full match between the invoicing to customers in the accounting
period and the revenue booked in the general ledger in the accounting period.
That’s the first similarity between accrued revenue and deferred revenue, we’ll get
into lots more detail on that.
Another similarity is that accrued revenue and deferred revenue
are both balance sheet accounts.
Accrued revenue is an asset, something that we as a company own, it goes on the left hand
side of the balance sheet.
Deferred revenue is a liability, it is something that we as a company owe, it goes on the right
hand side of the balance sheet.
In addition, both accrued revenue and deferred revenue are adjusting entries.
Adjusting entries are accounting journal entries that convert a company's accounting records
to the accrual basis of accounting.
We are basically dealing with the same subject matter,
but approaching it from different directions.
Accrued revenue is booked so we don’t understate revenue for the period.
Deferred revenue is booked so we don’t overstate revenue for the period.
Accrued revenue is sometimes called unbilled revenue,
while deferred revenue is sometimes called unearned revenue.
Let’s review accrued revenue and then deferred revenue in more detail.
The definition of accrued revenue is: revenue earned for goods or services delivered but
not billed to the customer yet.
An example is a service company that repairs and services heating systems in buildings,
that works with timesheets.
These timesheets are signed by the client for work performed in December, but the invoicing
system for December is already closed, so we will record an accrued revenue journal
entry directly into the general ledger to make sure we capture the revenue in the right period.
Here are the journal entries for accrued revenue.
Step one is the adjusting entry at period-end.
Debit accrued revenue on the balance sheet, credit revenue in the income statement.
Step two is to issue the invoice in the new accounting period.
Debit accounts receivable on the balance sheet, credit accrued revenue on the balance sheet.
This brings the balance of the accrued revenue account on the balance sheet back to zero,
it is cleared out.
Step three is for the customer to pay the invoice.
Debit cash, credit accounts receivable.
Deferred revenue deals with the exact opposite situation.
The definition of deferred revenue is: the obligation to deliver goods or perform services
in the future for which billing has already occurred and/or cash has been received.
Deferred revenue is a liability, because if you fail to provide those goods or services
in the future, you will have to pay the money back.
An example of deferred revenue is an upfront payment by a customer for a gym membership,
insurance, or a service contract, each of which could cover several months or even years.
From the customer’s perspective, this is a prepaid expense.
From the company’s perspective, this is treated as deferred revenue.
The customer pays the full amount of the contract upfront: debit cash on the assets side of
the balance sheet, credit deferred revenue on the liability side of the balance sheet.
For each of the subsequent accounting periods, you determine how much of the upfront payment
relates to that specific period, and record a debit to deferred revenue on the balance
sheet and a credit to revenue in the income statement.
At the end of the contract, the sum of the debits and the credits in the deferred revenue
account should be equal, it is cleared out.
Accrued revenue and deferred revenue: balance sheet accounts that receive adjusting entries,
in order to get the correct amount of revenue into the income statement of the period, as
we don’t want to overstate nor understate revenue!