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.

deferred_revenue_how_to_calculate-1.png

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.

deferred_revenue_calculate-1.png

What is deferred revenue? (video transcript from top of page)

Hi, I’m Claytone. I’m one of the founders here at SaaSOptics. And this is ask Claytone anything, a video series where I answer your most pressing questions about SaaS, financials and metrics. Today, we’re shooting from the top floor of the ask Claytone anything tower, and we’re talking about deferred revenue. What’s deferred revenue? I’m glad you asked. We spoke before about revenue recognition. In a nutshell, it’s an accounting principle, whereby revenues from a contract are recognized over time. As the services performed. For example, you sign a 12 month, $12,000 contract with a customer and you invoice the full amount upfront. You recognize the revenue. As soon as the invoice goes out the door, typically not instead, you should typically recognize pieces of revenue over time. As you perform the service. In our simple example, how much revenue would we recognize after a month? Well, this is easy. 12 month contract, $12,000. So after month one, we’d recognize about a thousand dollars in revenue and the remaining 11 K would put into a liability account under the Fargo, which is sometimes called unearned revenue. Now, because I’m crafty like that. I know what you’re thinking. You’re thinking a liability. Shouldn’t it be an asset, especially if I already got paid upfront? Nope. And accrual accounting, the exchange of cash is largely disconnected from your revenue recognition. Your rev rec is all about your performance obligations. And when you deliver the service, if you’ve only delivered one 12th of the service to your customer, you still are on the hook for the other 11 12th, therefore, a liability that you have an easy rule of thumb to help you remember deferred revenues. What’s been invoiced minus. What’s been recognized. Now it is accounting. So there are exceptions in gray areas and landmines and prison shanking in swarms of locusts. But that rule should keep you in straight. Most situations in my example seem easy enough, but this is only one customer. When you start scaling to hundreds or even thousands of customers and you factor in those pesky exceptions and landmines, we just talked about keeping track of deferred revenue becomes very difficult and error-prone that SaaSOptics. We do these complex calculations at scale. So you don’t have to worry about a botched Excel me. We can have it under the reporting. Pretty cool, huh? That’s right. I just use deferred revenue and cool in the same video. So there you have it duties. That’s deferred revenue. Join us next time for another ask Claytone anything.

 

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