What is Deferred Revenue?
Deferred revenue means the payment received by a company in advance for some products that are yet to be delivered or services that have not been executed and yet to be performed. Therefore, deferred revenues are categorized as the liability of a company on its balance sheet rather than considering as its asset. Another known term of deferred revenue is unearned revenue.
Revenue Recognition Principle
It is due to reporting purpose that a firm must categorize all its items considered either as liabilities or assets. For example, cash is always recognized as an asset. Now whenever a business gets prepayment as an advance for its order, the prepayment should be recognized as the liability as it stands for something that has not been earned yet. Therefore, the business is indebted to its customer. Only after delivering the products or performing the service to the concerned customer, the deferred revenue can be reconsidered as an asset.
In a case of flawless reporting of the assets as well as liabilities in the balance sheet of a company, deferred revenue plays an important role. It saves the company from the treatment of unearned income as its asset and protects from overvaluation of its net worth. If a company owns cash that is recognized as deferred revenue, it can be at risk until it delivers the work or product.