Could someone please explain deferred revenue?
In its simplest form, it's when you've received the cash for a service you haven't yet provided. In other words, someone paid you up front but you haven't yet earned the revenue. Think about a contract under which you will provide services for 36 months and someone pays you up front. It's not all revenue yet. You earn it over 36 months, so you have a liability (the deferred revenue) for all the money you are holding but haven't yet earned. Over time, the deferred revenue will reduce as it becomes revenue. Hope that helps.
That answer can either be really long and many pages, or really short. I'll opt for the latter.
When you sell something, you either deliver it now (e.g. a machine), deliver it later (e.g., a building), or a combination of the two (e.g., software with a 1 year service and support contract). Often the payments don't match the time frame over which the delivery takes place - for example, in the case of software, maybe you get paid $120,000 for the software and a year's service/support up front, but that product (the software AND the services) gets delivered over the course of a year.
So...how do you record it? You get the cash - the whole $120,000 payment - up front. But you can only record *revenue* as you deliver the entire product - that is, the software AND THE SERVICES. Revenue recognition rules are complex, and out of the context of this answer. Let's just assume you can recognize the Revenue over a year, so $120,000 / 12 months = $10,000 per month. Stated differently, Since you already have the cash, but you still have work to do (12 months of support), you recognize the Revenue over time - in this case, over 12 months. Month 1, you take the $10,000 to Revenue, and the remaining $120,000 - $10,000 = $110,000 goes onto the balance sheet as Deferred Revenue. Each month for the rest of the year, you take $10,000 to Revenue, and take down Deferred Revenue, so that by the end of the 12 month delivery period, it's $0 and the whole amount has gone to Revenue.
There can be many ways to recognize the revenue over time; that becomes the long answer.
Just to add to these fine answers, deferred revenue is a liability to the company for two reasons: One fully explained by Nick and Michael, you owe the services or products paid for, but the other is if for some reason you don't deliver (services or product) you owe the money back to the customer.
This concept is not always obvious to the new
In addition to the responses above, the principle of deferred revenue also has something to do with the Matching Principle.
If I may add one refinement to the above responses, typically the entry to record deferred revenue is made at the time of invoicing, not cash collection. (dr. Accts Rec, Cr. Deferred Revenue).
Does anyone have an accounting ERP system that keeps detailed project tracking of unbilled revenue and deferred revenue? Thank you.
Great answers and explanations above. Nothing to add.
We use NetSuite for billing and it records deferred revenue down to the invoice line item for every invoice. This involves setting up the billing to enable that of course.
I'm not sure how an unbilled revenue process would work, since there's really nothing for the system to apply if its truly unbilled. We consider usage for "last month", but billed in "this month" to be unbilled. But since the invoice is prepared "next month", I need to create a manual entry to post it to "this month".