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Deferred Revenue Explained | Adjusting Entries - YouTube
Channel: Accounting Stuff
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in this video we're going to work
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through an example of deferred revenue
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in accounting hey there welcome back to
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accounting stuff I'm James and in a
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moment's time I'm going to take you
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through all of the adjusting entries for
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a deferred revenue example two examples
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and just as a heads up this video is
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part of a miniseries I've created
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covering adjusting entries in accounting
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which you can find linked up here and
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down below in the description last week
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we do prepaid expenses and very soon
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I'll be making more videos covering
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accrued expenses and accrued revenue so
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hit the subscribe button and click on
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the bell so you don't miss out on any of
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those but today we're going to focus on
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deferred revenue let's get started as
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usual I'd like to keep things up with a
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definition deferred revenue is what we
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call the payments that a business
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receives in advance for goods or
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services that haven't yet been delivered
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or provided you might have heard of
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prepaid revenue or even unearned revenue
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well all of these are actually the same
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thing they're just different ways of
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saying deferred revenue okay
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that's bet on three different terms that
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all mean the same thing let's try to
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clear things up with a couple of
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examples in this first one I want you to
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imagine that you're the owner of a
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seaplane random I know but bear with me
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I live in Vancouver and for a while now
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I've been wanting to visit Vancouver
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Island if I were to take the ferry out
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there this whole trip would take me
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three to four hours but lucky for me you
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own a seaplane so ahead downtown to the
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seaplane terminal and boom there's a
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spot on your seaplane and it's leaving
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in 20 minutes the ticket cost me $200 so
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I pay you the money and half an hour
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later we're checking out the beautiful
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gardens on the island in this
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transaction Yerba seller and I'm the
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buyer you provided me with a service by
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flying me out from Vancouver all the way
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over to the island the question is how
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should you account for this transaction
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well as the owner of the seaplane you've
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received $200 in cash
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cash is a type of asset the a and dealer
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so debits increase it and credits
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decrease it your cash balance has gone
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up so you need to debit your cash
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account by $200 to increase your cash
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the other side of this transaction is
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going to affect revenue in your income
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statement revenue is the RN dealer a
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normal credit account so credits
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increase it and debes decrease it your
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revenue has gone up so you credit your
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revenue account by $200 to increase your
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income this is what your journal entry
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looks like and we can see how this
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journal entry affects your general
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ledger using T accounts sorry I've got a
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sore throat today this journal entry
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affects two accounts cash and revenue
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remember when using T accounts debits
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always go on the left and credits always
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go on the right so we debit your cash
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t-account by $200 to increase cash in
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your balance sheet
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andr credit the revenue t account by
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$200 to increase revenue in your income
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statement nice one that's the first
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example finished it wasn't so bad was it
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you're probably thinking well yes
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because there weren't any adjusting
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entries in this one you are spot on this
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transaction didn't include any deferred
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revenue or adjusting entries of any kind
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because both the payment and services
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happened on the same day in the same
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accounting period for deferred revenue
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to get involved in all of this we would
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need a special set of circumstances I
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would need to pay to you in advance
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in a past accounting period and you will
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need to be providing me with the service
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in the future accounting period I'll
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show you how this works in this second
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example this time no more seaplanes
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I want you to picture yourself as a
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commercial pilot on a passenger jet it's
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June and I'm getting homesick I want to
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buy a return flight from Vancouver to
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the UK to see all of my friends
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family it's been ages since my last
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visit so this time I decide to go there
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for a whole month I buy a return flight
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for $800 in June on your airline my
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outbound flight is going to be the next
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month in July and the return leg is
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going to happen the following month in
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August this is our timeline we have
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three accounting periods June July and
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August to account for this transaction
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you're going to need post three
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adjusting entries one in each month so
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let's do the first one in June I paid
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for my tickets but from your points of
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view at the airline you received $800 in
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cash you need to post a journal to debit
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your cash account by $800 to increase
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your cash right up to this point this
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journal is looking very familiar it's
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basically the same as the one from the
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first example you just need to post
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another $800 credit to revenue and we've
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got or this is embarrassing let me think
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you're a commercial pilot of an
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international airline large businesses
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like that use the accrual basis of
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accounting but if we were to recognize
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this income right now then we will be
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cash accounting because in cash
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accounting you record revenue as you
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receive the cash whoops so wasn't meant
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to credit revenue this time round
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because we are a cruel accounting okay I
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think I've got this now this time we
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don't credit revenue in the income
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statement because we are a cool
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accounting in accrual accounting revenue
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is recognized as is earned not when cash
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changes hands you haven't provided me
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with the service yet so you can't
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recognize any of this revenue so this
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entry can't go anywhere that affects the
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income statement so that leaves us with
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one option the balance sheet that is
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deferred revenue an asset or a liability
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let's work it out assets bring us future
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economic benefit whereas liabilities
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involve a future economic sacrifice in
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this situation I've already paid for a
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plane ticket so now it's down to you to
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fly me out to the UK and back you've got
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work to do so you are going to make a
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Yuja economic sacrifice so you need to
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recognize this deferred revenue as a
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liability in the balance sheet in fact
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deferred revenue is always recognized as
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a liability in the balance sheet so the
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other side of this journal entry is
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going to need to increase our deferred
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revenue in the balance sheet deferred
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revenue is a liability the L in dealer
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so it's normal credit account credits
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increase it and debits decrease it so
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you need to credit your deferred revenue
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in the balance sheet to increase it by
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$800 let's see how this journal affects
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your general ledger now you've got three
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T accounts cash and deferred revenue in
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the balance sheet and revenue normal
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revenue in the income statement your
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cash account has a debit balance of $800
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from my initial payment and your
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unearned or prepaid revenue account
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holds a liability of $800 the normal
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revenue account is empty because we
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can't recognize any revenue at this
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point let's fast forward to the end of
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July you've flown me out to London so
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half of my return trip is complete if
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revenue is recorded as is earned
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then you've earned half of your income
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the problem is as things currently stand
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you're holding $800 as a liability in
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the balance sheet this deferred revenue
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is not the same thing as normal revenue
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that flows through your income statement
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you're going to need post and adjusting
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entry to fix this situation let's do it
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we'll start off by debiting 2/3 revenue
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by $400 because we want to reduce this
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liability in the balance sheet and
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release half of it to the income
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statement but where does the other side
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of this adjusting journal entry go we
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need to credit to the revenue account by
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$400 to increase our revenue in the
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income statement let's jot down how this
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adjusting entry is going to affect your
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t accounts we need to debit the
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left-hand side of the deferred revenue T
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account by $400 and credit the
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right-hand side of the revenue t account
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by $400 so as things currently stand you
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have cash of $800 from that initial
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payment and you are holding 2/3 revenue
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of $400 as a liability
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in your balance sheet we've released the
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other $400 which we now recognize as
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revenue in the income statement in
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August you fly me back to Vancouver
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so the second leg of our round trip is
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complete you have one more adjusting
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entry to post this adjusting entry is
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going to be exactly the same as the one
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that we posted previously we need to
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debit deferred revenue by $400 to
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decrease it in the balance sheet and
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credit the normal revenue account by
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$400 to increase that in the income
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statement you post this adjusting
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journal entry and it hits your general
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ledger so in your August balance sheet
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you are still carrying that $800 of cash
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from the initial transaction but you no
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longer have any deferred revenue why
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because it has all been released to the
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income statement $400 in July when you
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performed half of the services and the
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other $400 in August where you completed
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the roundtrip you have successfully
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recorded your revenues as they were
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earned so your books are in line with
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the accrual basis of accounting nice one
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this was part three in the adjusting
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entries miniseries I'm going to be
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releasing more videos covering accrued
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expenses and accrued revenue very soon
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so click on this circle to subscribe so
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you don't miss out on any of those I've
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already made videos covering the big
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picture of adjusting entries and prepaid
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expenses which you can find in the
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playlist over here as always if you've
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got any questions let me know down below
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in the comments or message me directly
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on instagram at accounting stuff
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