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