What is Deferred Revenue?

Deferred revenue, also called unearned revenue, arises when customers pay in advance. Until you deliver, the money is a liability: you owe the customer either the product, the service or a refund.

Common examples

• Annual subscriptions and memberships billed upfront
• Class packs and prepaid service packages
• Customer deposits on construction or custom projects
• Gift cards not yet redeemed
• Retainers for services not yet performed

Example

A fitness studio sells a 12-month membership for $1,200 in January. Under accrual accounting, it records $1,200 of deferred revenue, then recognizes $100 of revenue each month as the membership is used.

Why it matters

Recording the full payment as revenue when received overstates income in the month of sale and understates it later. It also hides how much service the business still owes customers. See our page on fitness studio bookkeeping for a worked setup.

Tax timing

Tax rules on advance payments differ from book rules. Depending on your method, advance payments may be taxable when received or deferred in limited ways. The IRS discusses advance payments in Publication 538. Your preparer will apply the appropriate rule; the deferred revenue schedule in your books provides the detail they need.

Keeping a schedule

Maintain a schedule listing each customer's prepaid balance, the amount recognized each month and the remaining balance. Reconcile it to the deferred revenue account at every month end.

See also prepaid expenses, the mirror image on the buyer's side.

Related terms

• Accrual Accounting: Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when cash moves.
• Prepaid Expenses: Prepaid expenses are payments made in advance for goods or services the business will receive in future periods.

Browse more definitions in the small business glossary.