Deferred revenue, also known as 'unearned revenue', is money received by a company for goods or services that are yet to be delivered or performed. It is considered a liability on the company's balance sheet because it represents an obligation to the customer.
While the basic explanation gives an overview, there's more to deferred revenue. When a company receives payment for goods or services in advance, it cannot immediately recognize this as revenue. It becomes revenue only when the goods are delivered or the services are rendered.
The amount still to be earned is recorded as 'deferred revenue' on the liability side of the balance sheet. As the company delivers goods or provides services, it gradually reduces the deferred revenue and increases the actual revenue.
Deferred revenue is crucial in accurately representing a company's financial health. It ensures revenues and expenses are recorded in the period they are earned or incurred, irrespective of when the money changes hands, adhering to the accrual basis of accounting.
For Netflix, deferred revenue comes into play when customers pay their subscription fees at the start of the billing period. This money is initially recorded as deferred revenue and then gradually recognized as revenue as the month progresses and the service is provided.
Delta Air Lines collects money from customers when they book their flights. However, the company cannot recognize this money as revenue until the flight has occurred. Until then, it is recorded as deferred revenue on the company's balance sheet.
Microsoft often receives payments for its software and cloud services in advance. This advance payment is considered deferred revenue until the services are delivered over the duration of the contract, at which point it is recognized as revenue.