Understanding Deferred Revenue
Deferred revenue refers to payments received in advance for goods or services yet to be delivered. Such revenue isn't immediately registered as earned. Instead, according to accrual accounting principles, it's shown as a liability on the balance sheet.
Details of Deferred Revenue
When a firm receives upfront payment for undelivered goods or services, it's recorded as a liability known as deferred revenue. The revenue isn't recognized until the items or services are fully delivered to the customer. If the company fails to deliver, it may have to issue a refund, thus the prepayment is considered a liability and not an asset.
Occasionally, contract terms may prevent revenue recognition until the entire order is fulfilled. As a result, customer payments remain as deferred revenue until the agreed delivery is completed.
Why Deferred Revenue is Recorded
Companies record deferred revenue due to the revenue recognition principles of accrual accounting. These principles state that revenue is recorded when it is earned, and expenses are recorded when they occur, regardless of payment timing. Therefore, advance payments are recorded as liabilities because the company owes the goods/services ordered.
Revenue recognition is independent of payment timing, which can be random and uncertain. Businesses only recognize revenue upon actual earning or delivery of goods and services.