How Deferred Revenue Is Recognized and Presented on the Balance Sheet

Graziano Stefanelli
Oct 13
3 min read

Deferred revenue, also known as unearned revenue, represents income received by a company for goods or services not yet delivered or performed. It is a liability because it reflects an obligation to provide future economic benefits to customers. Under IFRS 15 and ASC 606, deferred revenue is recognized as a contract liability and transferred to income only when the company satisfies its performance obligations. This treatment ensures that revenue recognition aligns with the actual delivery of value.

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How deferred revenue arises

Deferred revenue arises whenever customers pay in advance for products or services that will be delivered in future periods. Typical examples include:

Annual software subscriptions.
Prepaid service contracts (maintenance, hosting, consulting).
Advance payments for goods not yet shipped.
Gift cards or prepaid memberships.

Example:A company receives 240,000 on January 1 for a 12-month subscription. At the end of each month, it recognizes 20,000 in revenue and reduces the deferred revenue liability accordingly.

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Presentation on the balance sheet

Deferred revenue is recorded as a liability because the company owes goods or services to the customer. It is divided between current and non-current portions, depending on when the obligation will be fulfilled.

Example:

Liabilities	Amount (USD)
Current Liabilities:
Accounts Payable	150,000
Deferred Revenue (within 12 months)	180,000
Non-Current Liabilities:
Deferred Revenue (beyond 12 months)	60,000

As the company delivers its services or products, deferred revenue is gradually recognized as income.

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Journal entries for deferred revenue

When cash is received in advance:

Debit: Cash 240,000
Credit: Deferred Revenue 240,000

When revenue is earned each month:

Debit: Deferred Revenue 20,000
Credit: Service Revenue 20,000

If goods are returned or contract is canceled:

Debit: Deferred Revenue (remaining balance)
Credit: Cash or Refund Liability

These entries ensure the timing of revenue recognition matches the completion of performance obligations under IFRS 15 and ASC 606.

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Standards under IFRS and US GAAP

IFRS (IFRS 15 – Revenue from Contracts with Customers): Deferred revenue is recognized as a contract liability when payment precedes performance. Revenue is recognized when control of goods or services transfers to the customer.
US GAAP (ASC 606 – Revenue Recognition): Identical principles apply. Companies must identify performance obligations, determine transaction price, and allocate it to each obligation.

Both frameworks emphasize the “five-step model” for revenue recognition, ensuring that revenue reflects actual value delivered rather than cash received.

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Impact on financial performance and ratios

Deferred revenue affects liquidity and profitability metrics because it delays income recognition while cash is already received.

Example:A company that receives 1,000,000 in prepaid subscriptions shows strong cash flow but lower current earnings, as revenue is deferred over the service period. This reduces reported profit margins in early periods but enhances earnings stability later as income recognition catches up.

Ratios influenced include:

Current Ratio: Increases temporarily due to cash inflow but offset by deferred liability.
Operating Margin: Initially lower since cash is received without corresponding revenue.
Cash Flow from Operations: Improves due to early cash collection.

Analysts often monitor deferred revenue trends to assess future revenue visibility and customer retention.

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Disclosures required for deferred revenue

Entities must disclose:

The opening and closing balances of contract liabilities (deferred revenue).
Revenue recognized during the period that was previously deferred.
The timing of performance obligations.
Key judgments about transfer of control and transaction price allocation.

These disclosures provide transparency about the link between cash receipts and recognized income.

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Operational considerations

Deferred revenue provides valuable insight into business momentum and customer commitment. For subscription-based and service-oriented companies, growing deferred revenue balances indicate future revenue assurance. However, excessive or persistent deferrals may suggest delivery delays or contract complexities that affect timing.

For management, accurate tracking of deferred revenue ensures compliance with IFRS 15 and ASC 606 while providing a reliable forecast of future earnings. For analysts and investors, deferred revenue reflects both operational discipline and the stability of customer relationships—a critical indicator for SaaS, telecom, and professional service industries.

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DATA STUDIOS

.....[datastudios.org]