Deferred revenue explained
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- เผยแพร่เมื่อ 28 พ.ค. 2024
- Deferred revenue: an accounting term that deals with a specific type of timing difference between getting paid by your customer and providing goods or services in return. This short video starts with real-life examples of deferred revenue in companies in very different industries, we subsequently discuss a common definition of deferred revenue, talk about why this is such a great business model, and review the deferred revenue accounting journal entries.
⏱️TIMESTAMPS⏱️
00:00 Introduction to deferred revenue
00:27 Deferred revenue examples
00:59 Deferred revenue: giftcards
01:31 Deferred revenue: subscription services
01:51 Deferred revenue: passenger tickets and frequent flyer miles
02:40 Deferred revenue definition
03:01 Deferred revenue business model
03:25 Deferred revenue journal entries
Let’s start with some examples. What do Home Depot, the world’s largest home improvement retailer, Salesforce, a leading provider of enterprise software, and United Continental Holdings, a transporter of people and cargo, have in common? Each of these companies has a significant amount of deferred revenue. Home Depot $1.7 billion, Salesforce $5.5 billion, and United $8.6 billion. If you have any more examples of deferred revenue, please share them as a comment!
How does deferred revenue work for Home Depot? Here are some excerpts from Home Depot’s annual report. “When we receive payment from customers before the customer has taken possession of the merchandise or the service has been performed, the amount received is recorded as Deferred Revenue in the accompanying Consolidated Balance Sheets until the sale or service is complete. We also record Deferred Revenue for the sale of gift cards and recognize this revenue upon the redemption of gift cards in Net Sales.”
How does deferred revenue work for Salesforce? “Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from subscription services … and is recognized as the revenue recognition criteria are met. … We generally invoice customers in annual installments.”
How does deferred revenue work for United? United actually has two types of deferred revenue, that are recognized in separate accounts on the balance sheet. The value of unused passenger tickets is included in current liabilities as Advance ticket sales until the time the transportation is provided: $3.7 billion. The second type of deferred revenue relates to frequent flyer miles. “Mileage Plus program participants earn miles by flying on United and certain other participating airlines. …. The Company records its obligation for future award redemptions using a deferred revenue model. … The miles are recorded in Frequent flyer deferred revenue on the Company’s consolidated balance sheet and recognized into revenue when transportation is provided.” This liability is $4.9 billion.
So what is the common theme, and an accurate definition of deferred revenue? Deferred revenue is a balance sheet account (on the liability side, what a company owes) representing the obligation to deliver goods or perform services in the future for which billing has already occurred and/or cash has been received.
If that accounting definition of deferred revenue still sounds a bit cryptic to you, then think of the business model in construction: step one is to sign a contract for work to be performed, then the construction contractor gets a down-payment from the customer, the contractor uses this to buy materials and labor, delivers the finished project, and recognizes the revenue.
Here’s how the journal entries for deferred revenue work step by step. We will record the journal entries for a two year service contract that runs from mid-2018 to mid-2020. 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 2018, we book six months’ worth of revenue: debit deferred revenue on the balance sheet, credit revenue in the income statement. At the end of 2018, 18 months of deferred revenue for the remainder of the contract is still on the balance sheet. For 2019, we book twelve months’ worth of revenue: debit deferred revenue on the balance sheet, credit revenue in the income statement. For 2020, we book the remaining six months of revenue. At the end of the contract, the sum of the debits and the credits in the deferred revenue account should be equal.
Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investment decisions. Philip delivers training in various formats: TH-cam videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!
Enjoyed this video on deferred revenue? Then subscribe to the channel, and watch my video on accruals next: th-cam.com/video/lBvnSgIGVnU/w-d-xo.html
that was a clear description of deffered revenue I ever received in my lfie,Thumps up
Thank you! Great to hear that. :-)
Thank you. Really enjoyed the explanation
Great to hear that, Martha! Thank you! I have done quite a few videos on various balance sheet items, have grouped them in a playlist: th-cam.com/video/na4jbAh_vkQ/w-d-xo.html
I have a business where i sold ebooks, and when i was starting and launch my first ebook, i do a presale, so with that money i will finance the website. The great advantage is that the ebook cost me $0 (is a PDF). ¡Great success!
That's great! Very convex and scalable. Love interacting with fellow entrepreneurs. Thanks for sharing the story/example!
The journal entries are great
Thank you! Yes, journal entries always help to visualize the steps. More on this in the video on adjusting entries: th-cam.com/video/57CST6_RtWk/w-d-xo.html
Thank you!
You're welcome!
Fantastic
Thank you! :-)
3:34 So if you break deferred revenue into debits and credits...it is essentially recorded as both a debit and credit (in terms of accounting) at the time of inception? In other words an asset is gained but liability is also incurred?
Hello Brandon! I don't really "break deferred revenue into debits and credits". Basically, I see cash coming into the bank account for which I have not done anything yet. Receiving cash in the bank leads to the debit in assets (cash). Where does the other side of the journal entry go? I promised to perform service (to a machine or instrument) in the future, I owe a service to somebody else, hence the credit in deferred revenue. You could see deferred revenue as a "promises made but not fulfilled yet" liability account. ;-) Once the service is actually performed, you then debit deferred revenue and credit revenue, in other words recognize the income in the profit and loss statement.
Is all the credit stored in starbucks accounts considered Deferred Revenue? Starbucks owes the service (Coffee) to the customers in the future but they have already received the payments/credits?
Yep! Good example.
Hi! I enjoyed your video. I think Tesla's FSD sales is another example of deferred revenue. And I have a question. When they do the wide release of FSD in North America according to Elon (🤞 😅), will they have significantly increased revenue due to this realized deferred revenue? Or is there any rule to realise the deferred revenue? Is it on their own? Again, than you for your video.
Hello! I am not familiar with the ins and outs of Tesla FSD. If customers have prepaid in cash for a service as yet to be released, then the amounts will transfer from deferred revenue (on the balance sheet) to revenue (in the income statement) once the revenue recognition criteria are met, which includes "Recognize revenue when (or as) the reporting organization satisfies a performance obligation". See also my video on revenue recognition: th-cam.com/video/816Q6pOaGv4/w-d-xo.html
Where did you come across the term "deferred revenue"? Let me know by commenting below!
I was checking out Boeing, and saw a 50.67B deferred revenue and I checked out your video
Would amazon prime memberships and gift cards be considered as deferred revenue ?
Hello Rondail! If you pay a membership twelve months in advance, then that would be deferred revenue, the company takes 1/12th of the amount as revenue as each month passes. If you pay for a membership month by month, then there's automatic "matching" between the payment and the month where the service is rendered and there's no deferral needed. Gift cards are a good example of deferred revenue (it's "cash in advance" for the company selling them, without delivery of goods and services yet), however the accounting for them has changed a bit recently with the new revenue recognition standard being implemented. Let me look it up and get back to you!
Found the following description for accounting for gift card revenue as deferred revenue, in line with what I responded above:
Gift card sales are initially recognized as a liability. The gift card revenue is recognized after a gift card is redeemed.
So if say Activision sells pre-orders for the next Call of Duty game and people buy the pre-order, that deferred...unrecognized revenue (because the game has not been released or delivered yet), would be a current liability on Activision's balance sheet? Is such deferred revenue in this case increasing Activision's cash balance or not, and what happens when customers cancel their pre-order, does the cash balance on current assets, go down?
Yes to all! :-) I always think through the accounting journal entries in these cases:
Pre-order made, paid in cash
Debit cash
Credit deferred revenue
Pre-order made ("solid commitment", as in legally binding, not just a vague intent to buy), invoice still to be paid by the customer
Debit accounts receivable
Credit deferred revenue
Customer cancelling pre-order, getting a cash refund
Debit deferred revenue
Credit cash
@@TheFinanceStoryteller Thanks a lot! Your videos are a joy to watch and are very helpful. Really appreciate it. 👍
Thanks for the kinds words! Happy to hear that. I enjoy putting the videos together. Good fun to dive deep into the topics.
What's the difference between deferred revenue and accural received?
My video on accruals (covering both accrued expenses and accrued revenue) hopefully answers that question! th-cam.com/video/lBvnSgIGVnU/w-d-xo.html If it doesn't let me know and I will try to help you.
What is the difference between prepaid income and deferred revenue
I had not heard of the term "prepaid income" before, but judging by the descriptions I am finding on the internet, it sounds like the same thing as deferred revenue.
So then Deferred revenue and Unearned service revenue are the same thing?
Hi Munamil. Yes, those are commonly used interchangeably. See also my video on adjusting entries: th-cam.com/video/57CST6_RtWk/w-d-xo.html
But in my accounting books Deferred Revenue expenses is treated as a long term or non current asset
This video covers deferred revenue, NOT deferred revenue expenditure. I have not come across the term "deferred revenue expenditure" before, it might be something that is used exclusively in India. Can you give me the definition from your textbook, so I can review it? It sounds to me like it could be the same as what is called "prepaid expenses" in other countries, but I would like to verify.
Microsoft has about 32B of deferred revenue
Correct! That is a great example as well. As a result of that, Microsoft working capital is a negative number: th-cam.com/video/XvHAlui-Bno/w-d-xo.html