What is Deferred Revenue
Deferred revenue is unearned revenue of the business for the undelivered goods and services. Deferred revenue is the advance payment received for the goods or services yet to be delivered. This means the company has not earned revenue yet. In accrual accounting, the company only records revenue when it is earned. I.e., if a customer pays in advance, the company does not show any revenue on its income statement and instead shows a liability on its balance sheet.
Deferred Revenue Explained
When a company gets paid in advance for something it hasn't been delivered yet, it records that payment as a liability on its balance sheet. This is called deferred revenue because the revenue is not recognized until the product or service is provided to the customer.
The company has the compulsion of the customer to deliver what they paid for, or else they might have to refund them. This is why the advance payment is a liability, not an asset. The company risks not fulfilling the order or losing the customer.
Sometimes, contracts have specific terms preventing the company from recognizing revenue until the whole order is completed. This means that the customer's payments will remain in deferred revenue until the company delivers everything they agreed to in the contract.
Why do companies record deferred revenue?
The reason why they have to do this is because of the revenue recognition principles of accrual accounting. This means that they record revenue when it is earned, not when it is paid. And they record expenses when they are incurred, not paid. So, they have to show these payments as liabilities, or a kind of prepaid expense in reverse, because they owe either the money or the goods/services that were ordered.
Consumer payment timing can be uncertain and random, i.e., Businesses ignore the timing of payment and only recognize revenue when it is actually earned or on the completion of delivery of goods and services