Deferred revenue is any type of revenue that is received as compensation for goods and services that will be delivered at some future date. This means that the money is actually collected before it is earned. It appears in the accounting records as a liability until such time that the goods and services are actually provided to the buyer; at that point, it can be recorded in the same manner as any type of collected revenue. The opposite concept is a deferred charge.
One of the simplest ways to understand the idea is by looking at what happens when an employer chooses to extend a salary advance to an employee. While the employee has not yet earned the funds that are extended by the employer, there is a reasonable expectation by both parties that the employee will eventually provide services that justify the compensation. Until the advance is actually earned, the employee essentially owes the amount of the advance to his or her employer. Once the debt is paid in full, the employee can reasonably consider the amount of the advance as earned income.
Deferred revenue is a compensation practice that is employed in a number of different professions. Contractors often request a portion of the final cost for a building project in advance. The expectation is that the contractor will complete enough work in short order to cover the amount of the advance, changing the payment to earned revenue. Service professionals such as plumbers and electricians may also require advance payment of a portion of their fees. Until the work is completed, the advance is also treated as unearned.
The designation is an important accounting tool that helps to keep the records straight on what has and has not occurred. Because deferred revenue is not treated in the same manner as unearned income, it is possible to use the accounting records as another information source for keeping jobs in progress on track. Listing this revenue as a liability makes it harder to lose track of what has and has not been done in regard to a particular customer project.
In some industries, deferred revenue is an efficient means of obtaining the resources necessary to carry out a project on behalf of a customer without tying up other company resources. For example, a contractor that is refurbishing a bathroom for a customer may use the advance to purchase all the supplies for the project rather than using his own money for the materials. This can help to ensure the contractor does not experience a short term problem with cash flow, as the only funds involved in purchasing the materials is unearned revenue.
