Understanding Deferred Revenue in Contracting Business Accounting

By James R. Leichter (aka: Mr. HVAC)

I get a lot of questions from my consulting clients that are related to: What is deferred revenue? How to make a deferred revenue journal entry. Deferred revenue meaning. Is deferred revenue an asset? Is deferred revenue a liability? I decided to write an article of the subject of deferred revenue and hopefully answer all of those deferred revenue questions in one place. I have also included an example of how to make an adjusting journal entry for deferred revenue that can be used in QuickBooks, Total Office Manager, and other accounting EP software.

What is Deferred Revenue?

Deferred revenue, also known as unearned revenue, is an important accounting concept, especially for HVAC and plumbing companies that often receive payments in advance for services. But what exactly is deferred revenue? In simple terms, deferred revenue represents money received by a company for goods or services that have yet to be delivered or performed.

Deferred Revenue Meaning

Think of deferred revenue as a promise—a promise to your customers that you will provide them with the services they’ve paid for. It’s like getting a subscription to your favorite magazine; you pay upfront, but the magazines arrive over time. Similarly, when your HVAC or plumbing company receives payment for a service contract upfront, that payment becomes deferred revenue until the service is actually provided.

Is Deferred Revenue a Liability or an Asset?

Is Deferred Revenue a Liability?

Yes, deferred revenue is a liability. Why? Because it represents an obligation to provide goods or services in the future. Until you fulfill this obligation, you owe your customers the value they paid for in advance.

Is Deferred Revenue an Asset?

No, deferred revenue is not an asset. An asset represents something you own that has value, such as cash or equipment. Deferred revenue, on the other hand, is an obligation—a promise to perform services or deliver goods in the future. Therefore, it is recorded as a liability on your balance sheet.

Deferred Revenue on Balance Sheet

Deferred revenue appears on the balance sheet under the liabilities section. It’s important to note that as you provide the services or deliver the goods, deferred revenue is gradually recognized as actual revenue. This transition moves the amount from the liabilities section to the revenue section on the income statement.

How to Record Deferred Revenue

Recording deferred revenue properly ensures your financial statements accurately reflect your business’s financial health. Let’s break it down with an example:

Example Adjusting Journal Entry

Imagine your HVAC contracting or plumbing company receives a $12,000 payment in advance for a one-year service contract. You need to record this payment as deferred revenue initially. In QuickBooks and Total Office Manager, select the account type of ‘Other Liability’ for your ‘Deferred Revenue’ account in your chart of accounts.

Here’s how the journal entry looks:

Journal Entry on Receipt of Payment:

Account                     | Debit ($) | Credit ($)
----------------------------|-----------|------------
Cash                        | 12,000    | 
Deferred Revenue            |           | 12,000

Each month, as you provide the service, you recognize part of the deferred revenue as actual revenue. For instance, after the first month, you would recognize $1,000 as revenue (since $12,000 divided by 12 months equals $1,000 per month):

Monthly Adjusting Entry:

Account                     | Debit ($) | Credit ($)
----------------------------|-----------|------------
Deferred Revenue            | 1,000     | 
Service Revenue             |           | 1,000

Repeat this process each month until the entire $12,000 is recognized as revenue.

In QuickBooks and Total Office Manager, select the account type of ‘Income’ for ‘Service Revenue’.

Define Deferred Revenue

To define deferred revenue simply: its money received for services or goods that have yet to be delivered. It’s an obligation to the customer, which is why it sits on the balance sheet as a liability until the services are performed or goods delivered.

Why is Deferred Revenue a Liability?

Deferred revenue is considered a liability because it represents a future obligation. When customers pay you in advance, you owe them the service or product they paid for. Until you fulfill this obligation, the payment is a liability on your balance sheet.

What Type of Account is Deferred Revenue?

Deferred revenue is a liability account. It’s listed under current liabilities if the service or product is expected to be delivered within a year. If the delivery is expected to take longer than a year, it can be classified as a long-term liability.

In QuickBooks and Total Office Manager, select the account type of ‘Other Liability’.

What Are Deferred Revenues?

Deferred revenues are simply amounts received by a business in advance of delivering goods or services. These amounts are recorded as liabilities until the corresponding goods or services are provided, at which point they are recognized as revenue.

Deferred Revenue Definition in Accounting

In accounting, deferred revenue is defined as revenue that a company has received but has not yet earned. This revenue is recorded as a liability on the balance sheet because it represents an obligation to deliver goods or services in the future.

Deferred Revenue Setup in QuickBooks®

In QuickBooks and Total Office Manager® from Aptora, select the account type of ‘Other Liability’ for your ‘Deferred Revenue’ account in your chart of accounts.

Summarizing the Importance of Deferred Revenue

For HVAC and plumbing companies, understanding and managing deferred revenue is crucial. It helps ensure that your financial statements are accurate and reflect the true financial health of your business. By properly recording and recognizing deferred revenue, you can avoid overstating your income and ensure that you meet your financial obligations to your customers.

Conclusion

Deferred revenue might sound like a complicated accounting term, but with a clear understanding and the right approach, it’s easy to manage. Remember, deferred revenue is a liability because it represents services or goods you still owe to your customers. Recording it accurately on your balance sheet ensures transparency and accuracy in your financial reporting.

So next time you receive an advance payment, remember this guide. Use it to confidently record and manage your deferred revenue, ensuring your HVAC or plumbing business remains financially sound and trustworthy in the eyes of your customers.

Quick Recap on Deferred Revenue

• Deferred Revenue Meaning: Money received in advance for services or goods yet to be delivered.
• Is Deferred Revenue a Liability?: Yes, it’s an obligation to provide future services or goods.
• Is Deferred Revenue an Asset?: No, it’s not an asset because it represents a future obligation.
• How to Record Deferred Revenue: Debit Cash, Credit Deferred Revenue; then recognize revenue monthly as services are provided.
• Why is Deferred Revenue a Liability?: It represents a promise to deliver future goods or services.

Now, you’re ready to tackle deferred revenue with confidence! Happy accounting!