Deferred Revenue Vs Unearned Revenue – Are They Different?

Deferred revenue or unearned revenue is essentially the same type of income. It is the income that is received before delivering goods or services.

In many cases, it comes in the form of advance payment for a large contract. Some contracts stipulate certain terms that require a proportion of the total amount to be paid in advance.

Let us discuss what unearned revenue is, its accounting treatment, and how important it is.

What is Deferred Revenue?

Deferred revenue refers to the revenue earned in advance by an entity when it has already received the revenue but the delivery of goods or services is pending.

Deferred revenue is a form of advance payment in business dealings normally. It is a common practice in professional service industries such as online subscriptions, marketing plans, online tutoring, and airline tickets.

In some cases, a service or goods delivery contract may result in confirmed revenue for a company. However, the contract terms may dictate to fulfill certain conditions before the payment is advanced.

The earning entity would record the deferred revenue when it fulfills these conditions. It means when it becomes eligible to record the deferred revenue. Until then, the entity cannot record deferred revenue.

What is Unearned Revenue?

By definition, unearned revenue is the revenue that an entity is yet to earn.

In practice, unearned revenue is the same as deferred revenue. They both represent the same revenue type. Deferred or unearned revenue or deferred income are different names associated with the same type of income.

Unearned revenue can only be recorded for entities using accrual accounting. Entities using cash accounting cannot record unearned or deferred revenue. If they receive income before delivering services or goods, they will record it as a cash advance payment rather than deferred income.

Primarily, cash accounting would also stipulate the same concept with different implementation guidelines.

The other entity would report a prepaid expense for the same amount. Thus, both entities would consider it as a prepaid expense and income respectively.

A reporting entity must follow the accounting principles when recording unearned revenue. An entity cannot simply record the full amount of revenue before fulfilling the terms of a trade contract. (Details below)

Deferred Revenue Vs Unearned Revenue – Are they Different?

Although both terms seem different, they represent the same type of revenue. Deferred revenue or unearned revenue is the same type of income.

By meaning, unearned revenue is the income that an entity has not earned yet. Whereas, deferred revenue is the income that an entity has earned but is “delayed” or deferred.

In practice, deferral refers to the delay in delivering the goods or services against which the entity has earned income. It means an entity cannot record the income as it has not yet fulfilled its trade contract with the counterparty.

However, since the accrual accounting practice allows for prepaid income and expenses, an entity is eligible to reasonably record deferred revenue in its account books.

Application of Deferred Revenue

Deferred revenue and prepaid expenses are important concepts in accrual accounting. Entities can record advance payments received and made when dealing with long-term contracts.

The concept of deferred revenue is particularly important in professional service industries. Modern subscription and service contract agreements depend largely on advance payments received from customers.

Here are a few key examples of the practical application of deferred revenue.

• Subscription Models: Most online subscription models use the deferred income concept. They receive advance subscription payments from subscribers and deliver content throughout the period.
• Airline and Hospitality Industries: A conventional example of deferred income is in the airlines and hospitality industries. Both of these industries receive deferred income from customers and provide services later on.
• Software Plans: A similar use to the subscription model is in the software industry. Most software plans are recurring and subscription-based these days.
• Recurring Contract Services: Some conventional contracts such as in hospitality are recurring in nature. The service providers often receive advance payment for these contracts which is recorded as deferred income.
• Long-Term Projects: Companies working on long-term projects also receive a significant proportion of revenue in the form of advance payments. This income is also reported as deferred revenue.

Advantages and Disadvantages of Using Deferred Revenue

One of the main advantages of using deferred revenue is to apply the accrual concept in practice. Many companies need to receive advance payment to get things going first.

Therefore, without following the accrual accounting principles of recording deferred income, their account books would not show accurate results.

Some Advantages of using unearned revenue include:

• Accounting for the full income in advance would lead to an overstatement of revenues in one accounting period and understatement in the other.
• The deferred income concept allows for applying the matching principle of accrual accounting.
• This concept helps professional service organizations that rely on advance payments and subscriptions.
• It depicts accurate income and expense reporting for companies following the accrual accounting.
• In practice, deferred income increases cash flow and improves the short-term liquidity of a company.

Although the concept of unearned income is widely used; it comes with some disadvantages as well.

• The reporting entity must record a liability at the beginning rather than income.
• Unearned income relies on the quality and timely delivery of future services or goods that may go wrong.
• Unearned revenue reported earlier needs to be reversed if the contract does not complete satisfactorily.

Accounting for Deferred or Unearned Revenue

A reporting entity must follow the accounting principles to record the unearned revenue in its financial statements.

First of all, deferred income cannot be recorded as regular income until the contract terms are fulfilled completely. Therefore, applying accrual accounting principles and using unearned revenue as a liability rather than income becomes more of a responsibility than a choice.

Accounting for deferred income requires a cautious approach. Generally Accepted Accounting Principles (GAAP) require an entity to account for unearned revenue carefully.

I mean an entity should not overstate unearned revenue. The entity should carefully evaluate the circumstances and report the least possible and certain income.

Then, an entity should gradually record unearned revenue as it delivers goods or services under the contract. The liability initially recorded on the balance sheet is reverses gradually and the entity records income in its income statement.

Journal Entries for Deferred Revenue

An entity recording deferred income will post two entries. First to recognize a liability on its balance sheet at the time of receiving advance payment. Second to recognize the income and remove the liability initially recorded.

First journal entry will try will be:

Account	Debit	Credit
Cash/Bank Account	$ XXXX
Deferred Revenue		$ XXXX

The entity can post gradual reversal entries to recognize income as it may not deliver full services or total goods immediately.

The second journal entry to recognize income will be:

Account	Debit	Credit
Deferred Revenue	$ XXXX
Sales/Revenue/Income Account		$ XXXX

Examples

Suppose a company ABC provides digital marketing services to one of its regular clients. The contract states that the client will make an advance payment for a period of 6 months.

Suppose we have the following contract information.

• Contract Amount:     $ 6,000           
• Contract Duration = 6 Months (recurring)
• Monthly Income = $ 1,000

Since ABC Company is yet to deliver the subscription services and it will take 6 months to fulfill the obligation, it will record a deferred revenue.

Account	Debit	Credit
Cash Account	$ 6,000
Deferred Revenue		$ 6,000

The company can gradually record its income and remove the deferred income liability.

For each month the journal entry will be:

Account	Debit	Credit
Deferred Revenue	$ 1,000
Income Account		$ 1,000

The full income statement for ABC company for these 6 months will be as below.

Month	Income	Deferred Income	Net Income
0	$0	$6,000	$0
1	$1,000	$5,000	$1,000
2	$1,000	$4,000	$2,000
3	$1,000	$3,000	$3,000
4	$1,000	$2,000	$4,000
5	$1,000	$1,000	$5,000
6	$1,000	$0	$6,000

If the company had a short-term contract, it would record only one reversal accounting entry.

Deferred Revenue Vs Accrual Revenue

Accrual income or accrued revenue is the opposite of deferred revenue. It is the revenue that has not yet been received from the client after delivering goods or services.

The concept of accrual is contrasting to deferrals. Since the entity has earned the income, it will recognize it as an asset in its balance sheet. Contrarily, the deferred income is recorded as a liability.

Therefore, the company will record the income in its income statement when the payment is received. Like deferred income, accrual income can also be recorded gradually.

Once the organization fully recovers the payment, it will record the full amount as income and the asset from the balance sheet will be removed.

Deferred Revenue Vs Unrecorded Revenue

Sometimes an organization can face a lag between its service delivery and invoice. In such cases, its earned revenue will be unrecorded in the income statement.

Therefore, unrecorded income is also a form of earned revenue but due to some reason, the entity is yet to record it in the financial statements.