Deferred revenue is a important accounting concept for SaaS companies who have long term agreements such as annual and multi-year subscriptions. We will explain why and how to calculate deferred revenue.
Deferred revenue is a balance sheet liability account that tracks revenue that has been collected in advance of being earned. This is a very common scenario for Software-as-a-Service (SaaS) companies who sell their products and services and collect money up front.
Your business sells your service in annual agreements and collects money up front. Let’s say Acme Corporation sells their Gold Plan for $12,000/year and closes the deal in January. According to accrual-based accounting rules, Acme can not report that full $12,000 of revenue in January. This is because the accrual basis for accounting says you must recognize revenue when it is earned. Acme does not earn that revenue only in January, they earn it by providing their service all year long.
How To Account for Deferred Revenue
There are two main steps for recording deferred revenue transactions. First you must record deferred revenue when the transaction takes place. This is typically done when you receive payment for your services.
Second, you must record earned revenue periodically over the term of the service. In our example above, this would be done monthly for 12 months.
Recording Deferred Revenue
In order to record deferred revenue against your company’s balance sheet, you would record the following journal entry:
- Debit Cash: $12,000
- Credit Deferred Revenue: $12,000
Debiting your Cash account is performed simply because you have received payment from your customer. You credit deferred revenue because you have received payment for services that you have not yet rendered.
Recording Earned Revenue
Each month, starting in January and ending in December, Acme would record $1,000 of earned revenue. This would be done with 12 monthly journal entries:
- Debit Deferred Revenue: $1,000
- Credit Revenue: $1,000
Every month throughout the annual agreement, Acme is decreasing their deferred revenue liability and recognizing $1,000 of earned revenue.
Things To Keep In Mind
There are a few very common scenarios for SaaS companies that you should keep in mind.
What if my subscription amount doesn’t evenly divide by 12?
For example, if your annual subscription fee for your service is $10,000 you might be tempted to record $833.33 per month for 12 months. Except $833.33 x 12 = $9,999.96. This can throw off reports and create inaccuracies. You would want to record your earned revenue as follows:
- January: $833.33
- February: $833.33
- March: $833.33
- April: $833.33
- May: $833.33
- June: $833.33
- July: $833.33
- August: $833.33
- September: $833.34
- October: $833.34
- November: $833.34
- December: $833.34
If you use a cloud accounting application such as QuickBooks Online, ProRata can help you automate this process.
What if I accept credit cards? How do I handle the fees?
If you accept credit cards then you won’t be able to simply Debit Cash for the full amount when you receive payment. Chances are that you will be charged a processing fee from your payment gateway. In this scenario your Journal Entry would look like:
- Debit Cash: $970.70
- Debit Credit Card Fees: $29.30
- Credit Revenue: $1,000.00
ProRata was designed for SaaS and service based companies for these reasons. ProRata integrates with QuickBooks to make tasks such as revenue recognition much easier. Take a look at all the features ProRata has to offer your business.