Published in: Accounting

Deferred Revenue Journal Entry with Examples

Author Obotu Agape Oguche

Published on: November 9, 2022

What is the deferred revenue journal entry? Deferred revenue is recorded in the books, under accrual accounting, when a company receives advance payment from a customer for a product or service. This kind of advance payment is an asset to the customer that pays which is reported as prepaid expenses in the customer’s books.

However, to the company (who receives this payment), the prepayment is treated as a liability known as deferred revenue. Hence, as a liability, the deferred revenue journal entry will be a credit and an adjusting entry will be made later when the paid goods or services have been delivered.

In accrual accounting, deferred revenue is treated as a liability and not as revenue, because it is the money paid to a business in advance before it actually delivers the products or services to the customer. Hence, the business is indebted to the customer and is obligated to deliver the products or service at a later date. In this article, we will discuss the deferred revenue journal entry with examples as well as the deferred revenue adjusting entry.

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Deferred revenue explained

Deferred revenue also known as unearned revenue or prepaid revenue is the income that is received for a product or service that has not yet been delivered or rendered. It is referred to as unearned revenue because the company has made revenue from the advance payment received but hasn’t actually earned it yet because the goods or services are yet to be delivered. Due to an advance payment, the seller incurs a liability which is the revenue amount received until the good or service is delivered.

Hence, deferred revenue is treated as a liability and is converted from liability to actual revenue when the distribution or delivery of what the customer paid for has been done. Hence, the initial deferred revenue journal entry that was made when the prepayment was received will be adjusted to record when the company or individual delivers the goods or service to the customer.

Until the goods or service has been delivered, unearned revenue is recorded under current liabilities, because it is expected to be settled within a year. This can only change if the advance payment made is due to be provided 12 months or more after the payment date. In such a case, the deferred revenue will appear as a long-term liability on the balance sheet.

Typical examples of when unearned revenue is recorded include a rent payment made in advance, airline tickets, annual magazine subscriptions, services contract paid in advance (deferred service revenue), prepaid insurance, a legal retainer paid in advance, etc. When an advance payment is made to cover a certain number of months, as the months go by, a certain amount of deferred revenue is earned. Hence, the deferred revenue to be earned for a month is calculated by dividing the advance amount received by the number of goods or months of services for which the amount is received.

For instance, if a professional fee of $12,000 were received for six months. In order to calculate the deferred revenue that will be earned for a month, the $12,000 deferred revenue will be divided by the 6 months that were paid for, which will give us $2,000. This $2,000 is what is recognized as the earned revenue per month.

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The journal entry for deferred revenue has to be a credit entry because it is recognized as a liability. If a business doesn’t treat deferred revenue as a liability and recognizes it instead as revenue at once, revenues and profits would be overstated initially, and then understated for the additional periods in which the revenues and profits should have been recognized. Also, not recognizing deferred revenue as a liability would mean that the company would be recognizing revenues at once, and the related expenses would not be recognized until later periods which would be a violation of the GAAP matching principle.

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How to record a deferred revenue journal entry

Using the accrual system of accounting, many businesses would only recognize revenue when the goods or services have been delivered to the customer. Hence, if payment has been received in advance for a good or service that is yet to be delivered, it is a liability and as such will have an initial deferred revenue journal entry that would be entered as a credit. According to the accounting debit and credit rules, all revenues, liabilities, and equity accounts are credits. Hence, they increase with a credit entry and decrease with a debit entry.

Therefore, how to record deferred revenue journal entry is to make a credit entry to the deferred revenue account and a debit entry to the cash or bank account. This deferred revenue journal entry will show that the business has an influx of cash that has not yet been earned. Hence, the initial journal entry for deferred revenue will be as follows:

Deferred revenue journal entry to record influx of cash that has not yet been earned

As shown in the deferred revenue journal entry above, the initial entry to record the advance payment for goods or services not yet delivered would be a debit to the cash or bank account and a credit to the deferred revenue account because this revenue is a liability for the recipient of the payment. Hence, unearned revenue is a credit and not a debit. This means that the normal balance for unearned revenue or deferred revenue is a credit balance.

Furthermore, even though revenue was made from the prepayment received, this revenue is unearned and will not be entered into the company’s income statement. It will only be recognized on the income statement as revenue when it has been earned by delivering the prepaid goods or services to the customer. Until then, deferred revenue is reported on the liability side of the balance sheet to show that the company owes the recorded amount in terms of the goods or services yet to be delivered.

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Deferred revenue adjusting entry

When the deferred revenue has been earned, by the company delivering the goods or services that were paid for, the liability of deferred revenue decreases, and revenue increases. This means that when the company later delivers the good or service owed to the customer, a deferred revenue adjusting entry is made. How to record deferred revenue adjusting entry is to decrease the deferred revenue account by a debit entry, and increase the revenue account by a credit entry.

Also, when an advance payment is made to cover a certain number of months, as the months go by, a certain amount of deferred revenue is earned. Hence, the deferred revenue to be earned for a month is calculated by dividing the advance amount received by the number of goods or months of services for which the amount is received. This amount that is earned is what is recorded as the deferred revenue adjusting entry.

Hence, the deferred revenue adjusting entry will be as follows:

Deferred revenue adjusting entry to record the delivery of prepaid goods or services

A deferred revenue account is used when using accrual basis accounting, not with cash basis accounting. This is because, for cash basis accounting, revenue and expenses are only recorded when cash is actually received or paid. Whereas, in accrual accounting, revenue and expense are recorded as they are incurred rather than when money actually changes hands. Hence, deferred revenue is recorded only when using accrual accounting.

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Deferred revenue journal entry examples

Deferred revenue is recorded in the balance sheet when a company receives advance payment from a customer for a product or service. Using accrual accounting, this kind of advance payment as earlier said is treated as a liability and as such the deferred revenue journal entry will be a credit entry to increase the account and a deferred revenue adjusting entry will be made later when the paid goods or services have been delivered to decrease the deferred revenue account.

Common examples of when unearned revenue is recorded include a rent payment made in advance, prepaid insurance, annual magazine subscriptions, and services contracts or goods paid in advance. We will look at the deferred revenue journal entries for these mentioned examples.

Also, when an advance payment is made to cover a certain number of months, as time goes by, a certain amount of deferred revenue is earned. Hence, the deferred revenue to be earned for a month is calculated by dividing the advance amount received by the number of goods or months of services for which the amount is received. This is the deferred revenue adjusting entry recorded, which we will also show in the examples below:

Deferred revenue journal entry example 1: Rent payments received in advance

Receiving as advance payment of rent (prepaid rent) is a common example of when a company or business records deferred revenue. Let’s look at a deferred revenue journal entry example for rent payments made in advance. Assume Mr. Peter is a landlord and receives a 12 months advance rent payment from his tenant. Say, the tenant pays him $12,000 to cover 12 months. Mr. Peter will record this $12,000 received as deferred revenue in his books which will be a liability to him.

Hence, the deferred revenue journal entry for the $12,000 rent payment received in advance will be recorded as:

The deferred revenue journal entry to record the $12,000 rental income received in advance

For each month, the rental income for this $12,000 deferred revenue that Mr. Peter would earn would be calculated as:

$12,000/12 months = $1,000

Therefore, after each month, Mr. Peter earns $1,000 in rental income and makes a deferred revenue adjusting entry for each month as:

Deferred revenue adjusting entry to record $1,000 rental income that has been earned for each month

After 12 months, Mr. Peter would have earned the whole $12,000 which will be reflected in his books as:

The deferred revenue journal entry to record $12,000 rental income that has been earned after 12 months

As seen above, a deferred revenue adjusting entry is made to record the amount of deferred revenue that has been earned. This adjusting entry will reduce the deferred revenue account on the balance sheet and increase the revenue account on the income statement.

Deferred revenue journal entry example 2: Services contract paid in advance

A services contract income that has been received in advance is another example of when a company or business records a deferred revenue journal entry. Let’s say a contractor receives $100,000 from his client for a project. Assume, this contract is to be executed over ten months. The contractor will record this amount of $100,000 paid to him as deferred revenue in his books because he is yet to complete the job. Hence, the deferred revenue journal entry for the $100,000 contract paid in advance will be recorded as:

The deferred revenue journal entry to record $100,000 service contract income received in advance

The amount that the contractor would recognize as income on a monthly basis for the next ten months in the contractor’s books would be:

$100,000 / 10 months = $10,000

Hence, after each month, the contractor earns $10,000 in contract income and makes a deferred revenue adjusting entry for each month as:

After 10 months, the contractor would have earned the whole $100,000 which will be reflected in his books as:

Deferred revenue adjusting entry to record $100,000 service contract income that has been earned after 10 months

Deferred revenue journal entry example 3: Prepayment for newspaper subscriptions

Prepayment for subscriptions, be it magazines, software, or newspaper is also an example of when a deferred revenue journal entry is recorded in the books. For example, a publishing company receives $1,200 for a 12-month subscription. The publishing company will record this amount received as unearned revenue. Hence, the deferred revenue journal entry that will be made will be an increase to the cash account and an increase to the deferred revenue account. That is the journal entry for deferred revenue to record prepayment for newspaper subscriptions would be:

The deferred revenue journal entry to record a $1,200 prepayment for newspaper subscriptions

Let’s assume the newspaper is a monthly publication, which means that as each periodical is delivered, the deferred revenue is reduced by the monthly income of $100 (i.e $1,200 deferred revenue/12 months) while the revenue account is increased by $100.

Hence, the publishing company will record the $100 earned as:

After 12 months, the publishing company would have earned the whole $1,200 which will require the deferred revenue adjusting entry as shown below:

Deferred revenue adjusting entry to record $1,200 newspaper subscription income that has been earned after 12 months

Deferred revenue journal entry example 4: Advance payment of goods

Goods paid in advance are another common example of when a business would record a deferred revenue journal entry. For instance, Cindy stores orders some clothing items from Anne’s Apparel and makes an advance payment of $120,000. Cindy stores pay Anne’s Apparel in advance so that when the goods get shipped in, she will be given her order. At the time of payment, Anne’s Apparel has not yet earned the revenue, so she records all the $120,000 paid in the deferred revenue account. In order to record a deferred revenue journal entry for the goods paid in advance, Anne will record:

The deferred revenue journal entry to record a $120,000 advance payment received for goods

Anne’s Apparel expects to deliver the goods to Cindy’s stores in a month’s time but unfortunately not all the goods arrived and so she was only able to deliver $50,000 worth of goods out of what was paid for. Hence, Anne will make a deferred revenue adjusting entry to record the goods that have been delivered to Cindy:

The deferred revenue adjusting entry to record the $50,000 worth of goods that has been delivered

After 2 months Anne was able to deliver the remaining goods and records the delivery of goods to Cindy as:

The deferred revenue journal entry to record the remaining $70,000 worth of goods that has been delivered

Deferred revenue journal entry example 5: Prepaid insurance

Let’s assume you pay an insurance premium of $2,400 on Nov 20th to an insurance company for the 6-month period of Dec 1st through May 31st. The insurance company will record this as:

The deferred revenue journal entry to record a $2,400 insurance premium received

On Dec 31st, a deferred journal adjusting entry will have to be made to show the insurance amount that has been earned (which you have used up). That is the company has earned one-sixth of the $2,400 that you paid which is $400. This will be recorded as:

The deferred revenue adjusting entry to record one-sixth of the $2,400 premium that has been earned

Therefore, at the end of the 6 months, the insurance company will earn the complete $2,400 insurance premium cost and record it as:

The deferred revenue adjusting entry to record the $2,400 insurance premium cost that has been earned after 6 months