What is deferred revenue?
Deferred revenue is a liability for goods or services you have received cash or invoiced for, but not yet to delivered to the customer. It sits on the balance sheet as a liability, not as income, because you still owe the customer the service. You recognise the revenue as you deliver, usually over the course of a contract or in line with project milestones.
What is deferred revenue?
Deferred revenue is a liability which represents an obligation to deliver goods or services that a customer has already been billed for. Revenue is recognised over time or at a point in time, as or when the good is delivered or a service is performed and until then the billed amount must be recognised as a liability, not an asset.
A common example is where you invoice an annual subscription in full on day one. Whilst the customer is invoiced or has paid for the whole year up-front, they are receiving the service over the course of the full 12 months. Recognising the whole invoice immediately would overstate the first month's revenue and understate the eleven that follow, and it would misrepresent the obligation you are carrying. We hence need deferred revenue to represent this within our accounts.
You may see this balance called deferred revenue, unearned revenue or deferred income. Under IFRS 15, amounts relating to consideration received or due before the related performance obligations are satisfied are generally recognised as a contract liability. The first three are largely alternative labels, while “contract liability” is the more specific IFRS 15 terminology.
Is deferred revenue a debit or a credit?
Deferred revenue is a credit balance, because it is a liability. Conceptually, this makes sense as it is a representation that you have received consideration for a good or service which is still “owed” to your customer.
If your deferred revenue account is showing a debit balance, something is wrong and you should investigate the cause.
The deferred revenue journal entries
Take an £12,000 annual subscription (VAT is ignored for simplicity) invoiced on 1 July for the twelve months to 30 June.
When you raise the invoice, none of it is revenue:
- Debit Accounts Receivable £12,000
- Credit Deferred Revenue £12,000
The customer paying does not impact the revenue position, only the assets on the balance sheet:
- Debit Cash £12,000
- Credit Accounts Receivable £12,000
At each month end, you recognise 1/12th of the revenue:
- Debit Deferred Revenue £1,000
- Credit Revenue £1,000
After July, revenue is £1,000 and deferred revenue is £11,000.
At the end of the subscription, the full year’s revenue has been recognised and deferred revenue is nil.
An alternative method: recognise first, then defer
There is a second, equally valid way to reach the same position. Instead of posting the invoice straight to deferred revenue, you post it first to a revenue (profit and loss) account, and then move the unearned portion out to deferred revenue at month end. In practice this is often how it happens, because accounting systems such as Xero and QuickBooks Online post sales invoices to a revenue account by default.
Using the same £12,000 example:
- When you raise the invoice: Debit Accounts Receivable £12,000, Credit Revenue £12,000
- At the first month end, move the eleven unearned months out of revenue: Debit Revenue £11,000, Credit Deferred Revenue £11,000 (leaving £1,000 recognised for July)
- Each following month, release one month back to revenue: Debit Deferred Revenue £1,000, Credit Revenue £1,000
Both methods leave exactly the same revenue and deferred revenue balance at every month end. The only difference is where the invoice lands first and the direction of the month-end journal, so the choice is a matter of workflow rather than of accounting treatment.
Variations in the recognition of revenue and release of deferred revenue
- If the service does not start on the first of the month, the first month's release can either be prorated for the days of service provided or, under a monthly convention, recognised as a full month's revenue. The important thing is to apply the chosen convention consistently.
- If the service is not provided evenly across the contract, then deferred revenue should not necessarily be released evenly. In this case, judgement is required to determine when and to what extent the performance obligations are being satisfied. This is an accounting judgement, informed by factors such as the nature of the service, the pattern of delivery and key milestones in a project. This will be a key area of scrutiny during an audit.
Deferred Revenue Schedules
Keeping track of deferred revenue and posting journals for one contract or customer is easy enough, but for most businesses a deferred revenue schedule will be required.
A deferred revenue schedule is often a spreadsheet with one row per contract, which tracks the release of deferred revenue over time, and has a closing balance that agrees to the general ledger.
Is deferred revenue a current or non-current liability?
Deferred revenue will most likely be a current liability, unless the good or service is not expected to be delivered or performed within the next 12 months. In that case, in line with the usual classification for assets and liabilities, it will be a non-current liability.
Longer term contracts will see a split between current and non-current classification. For example, a three-year contract billed up front will have one year of current deferred revenue and two of non-current deferred revenue.
This split is not fixed: it is reassessed at each reporting date, so the non-current portion of a longer contract is reclassified to current as delivery comes within the next twelve months. A balance that is non-current this year therefore rolls into current in a later period.
Getting this wrong will not mean your total liability balance is inaccurate, but it will distort key metrics such as working capital and current ratios, which is exactly what finance teams, lenders or investors should be looking at.
Deferred revenue and accrued revenue are not the same thing
Both sit between invoicing and delivery, in opposite directions.
Deferred revenue is billed ahead of delivery: a liability, cleared by delivering.
Accrued revenue is delivered ahead of billing: an asset, cleared by raising the invoice.
Work done in the last week of the month and invoiced in the next is accrued revenue; an annual subscription paid up front is deferred revenue.
The confusion is worth taking seriously because getting it wrong will mean that revenue, assets and liabilities are all over or understated.
How to reconcile the deferred revenue balance
The total remaining across every open schedule should equal the deferred revenue balance in the general ledger at the same date. That reconciliation is the control, and it only works if you run it monthly.
When it does not agree, the usual causes are an invoice coded to deferred revenue that never made it onto a schedule, a recognition journal posted at a value the schedule does not hold, a schedule amended after the journal was posted, or a credit note applied to the invoice alone. Each of those is a single afternoon if you catch it in the month it happened, and a full trawl of the year if you leave it to the audit.
Contract changes are the other reliable source of drift. On an upgrade, close the original schedule at the change date and start a new one for the revised value over the remaining term, rather than editing the original in place, which is what makes prior periods stop agreeing. On cancellation, stop releasing and clear the remaining balance in the period the contract ends, matched to the credit note.
How do you automate deferred revenue at month end?
Done manually, deferred revenue is often calculated in a spreadsheet with a schedule for each contract. Someone reviews the contracts or invoices, determines how much revenue should be recognised in the period, rolls the schedule forward, updates the amounts, and then posts the journals into the general ledger. The work is not difficult when the underlying treatment is straightforward, but it is repetitive, and mistakes can occur when there are many contracts or month-end is under time pressure.
Deferred revenue automation software takes care of many of these processes for you. The tool stores the contract value and service period, calculates the release schedule, rolls the schedule forward each month, and shows what is due to be recognised for the period. It can then draft or post the corresponding journals into the general ledger. Because the schedule and the postings are part of the same record, the deferred revenue balance and revenue recognised can be reconciled to the underlying schedules by construction rather than by investigation.
For a straightforward service provided evenly over time, scheduling and posting are mechanical and can be automated. Where the pattern of delivery is more complex, determining the appropriate recognition pattern requires accounting judgement, and that should stay with the finance team.
How Mayday handles deferred revenue
Mayday's deferred revenue software shows you the invoices requiring deferred revenue treatment for that month and Mayday’s AI suggests the correct accounting treatment. You review the suggestions and then Mayday builds the deferred revenue schedule for you, and drafts the recognition journals ready for you to post with one click. The schedule and journals are created simultaneously, so the balance reconciles to the schedule rather than to a manual spreadsheet that has been edited all year.
Mayday is not invoicing or billing software, and it does not recognise revenue without you: review, validation and approval stay with the finance team. For more on the software category and how it differs from a standards-led revenue engine, read revenue recognition automation. For the expense-side equivalent, where a cost is incurred before the invoice arrives, read month-end accruals.
If you'd like to see how Mayday could automate your deferred revenue process, sign up for a 30 day no-card free trial today or book a demo with one of the team.