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What is Deferred Revenue and Why is it a Liability?

Deferred Revenue and Why is it a Liability

Accounting is a complex matter, and it affects every business. If the business fails to maintain a proper accounting journal, it costs more than investing in the matters and records of business accounting. In accounting, there is a term called deferred revenue. 

This deferred revenue plays a crucial role due to its very nature. It is revenue since the business has earned from it, but it can not be included under the revenue. This duality is not without reason, and we will be discussing all that. 

What Is The Exact Meaning Of Deferred Revenue?

The Exact Meaning Of Deferred Revenue
The Exact Meaning Of Deferred Revenue

So, we first need to understand deferred revenue and how it is earned. Deferred revenue can easily be stated as an advance the business receives for services they are about to provide. The client pays for the good or service prior to it being delivered. From the business perspective, it is nothing short of goodwill. 

As the money is earned and the service is due, the business cannot technically consider the available amount as an income. When the deferred or unearned revenue cannot be added under liabilities, it is put under the liabilities section. This is because the amount has not yet been recognized or recorded as revenue under accrual accounting. 

In the case of revenue, the amount immediately goes through the revenue recognition process to be recorded as revenue under accrual accounting. Without completing this process, revenue is not considered as revenue, hence, deferred revenue is not initially counted as revenue. 

The Relation Between Deferred Revenue And Accrual Accounting

The Relation Between Deferred Revenue And Accrual Accounting
The Relation Between Deferred Revenue And Accrual Accounting

Many business ventures take up the method of accrual accounting. Under this method, an amount is only recorded as revenue when it has been earned. So, the business has to sell a product or service and acquire the money for the items sold to put it in the books. 

This accrual accounting crosses out any chance of acquiring an advance, as it will not only be recorded as revenue, it will be counted as deferred revenue under the liabilities section. This is a precaution the company must take in case items or services are not delivered in due time; the money can be transferred back to the client’s account, leaving no confusion in the accounting books. 

In the meantime, the amount is recorded as deferred revenue as a liability. This liability is turned into a revenue figure by delivering the goods and services in due time. As soon as this action is complete, the unearned revenue becomes earned. Accrual accounting recognizes this as a sale or revenue and adds it to the books as revenue. 

What Are the Reasons For Considering Deferred Revenue As A Liability?

the Reasons For Considering Deferred Revenue As A Liability
the Reasons For Considering Deferred Revenue As A Liability

The recognition or receipt remains unearned until the goods and services are delivered. The company must clear all debts against its customers to earn revenue. The reasons for such a condition are discussed below in detail. 

  • Simply put, the company is in debt until they deliver their part of the deal. Then, if the customer issues a refund, the company is liable to give back the money paid in advance. This is why deferred revenue is not counted as actual revenue, as there is no stability in the amount, and the company capital may fall prey to the debt. 
  • Unearned revenue cannot be considered revenue under the accrual accounting process. The guidance model for accrual accounting singlehandedly prevents the deferred revenue from being utilized until the services are provided. The company is obligated because their part of the commitment is still due. 
  • The accrual accounting process can be stated as conservative as it does not dabble in risks. However, the revenue recording process can be delayed when you put deferred revenue under liabilities and wait for it to get recognized eventually in the future.

Conclusion

Deferred Revenue
Deferred Revenue

There is nothing to state against deferred revenue or consider it risky. It is just that accrual accounting takes a different approach in terms of accounting. After all, deferred revenue eventually turns into revenue in most cases. Putting the deferred revenue under liabilities may slow down the revenue counting process, but it is also a cautionary tale, so the business does not have to meet with debt. 

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