What is deferred revenue in a SaaS or subscription business?
Revenue Recognition, commonly referred to as rev rec or revenue rec, is an accounting principle and a process for reporting revenues by recognizing the monetary value of a transaction or contract over a period of time as the revenue is “earned.” The method of allocation and the period of time are determined by the application of rules, guidelines, and findings from organizations such as the Financial Accounting Standards Board (FASB) and the SEC.
Why is deferred revenue important?
Deferred revenue is a balance sheet liability account. Deferred revenue is equal to the value of invoices to date over the recognizable revenue to date calculated by customer contract and then aggregated and reported in summary form. Because deferred revenue is a balance sheet item, it is always calculated at a point in time.
Note if the calculation for a contract produces a negative number, the value is included in Unbilled AR, a balance sheet current asset.
How do you calculate deferred revenue?
Let’s look at two examples to illustrate how deferred revenue for a subscription is impacted by invoicing differences.
Example Subscription #1
- A one-year 12,000 subscription.
- The subscription start date and revenue start date are the same, April 15, 2013
- The subscription end date and revenue end date are the same, April 14, 2014.
- The subscription is invoiced all on the subscription start date of April 15, 2013.
In the image below, there is an invoicing schedule, with one record, and a revenue recognition schedule with a record for each month of revenue recognition over the term. In use is the proper daily amortization schedule.
Period Revenue is the revenue schedule by month, Note that April 2013 is approximately 1/2 the other months because the start date is April 15.
Recognized Revenue as of End Period is the rolling total of revenue recognized as of the end of that month.
“Deferred Revenue Balance as of the End of the Period” is the last column. This displays the value as of the last day of the month. If the schedule were shown in daily records, the Deferred Revenue Balance would be 12,000 as of April 15 and would decline by an equal amount until April 30, where the balance would be 11,473.97, the first row in the revenue schedule table below.
Example Subscription #2
In this example, the only change is that the invoicing is quarterly over the term. The value and dates of the subscription are identical. A one-year 12,000 subscription has an order date of April 1, 2013, a subscription start date and revenue start date of April 15, 2013, and a subscription end date and revenue end date of April 14, 2014.
In the Revenue Schedule table, the values in columns 1, 2, and 3 are identical to that in Example 1 above. The last column, Deferred Balance as of the End Period,” is different. Here you can clearly see the impact of invoicing on deferred revenue. Notice how the value at the end of the period bounces up and down, with peaks in the months where there is an invoice.
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