This requires a differentiation between realized and earned revenue. Realized revenue is revenue received regardless of whether the company has fulfilled its obligations to the purchaser. Realized yet unearned revenue is the subset of revenue which must be deferred. [5] X Research source For instance, say a magazine company receives a twelve-month subscription for a monthly publication. The subscription costs $120, and the subscriber pays the entire cost of the subscription up front. Thus, before the company delivers any magazines to the customer, the $120 is classified as deferred revenue and represents a liability to the company. In other words, the revenue has been realized but not yet earned.
This includes items that have been paid in full but await shipment, as well as subscription-based revenues where the subscription period is still ongoing. Once these transactions have been identified, the accounting staff must calculate and record the amount of the deferral.
In the example from Part 1, the company receives a $120 advance payment relating to a twelve-month magazine subscription. When the company receives payment (but before delivering the subscription), the company must record the entire amount of the payment as deferred revenue. To do this, the accounting staff will post the following journal entry: Debit Cash $120 Credit Deferred Revenue ($120)
Consider the magazine subscription example. After the first month of the subscription, $10 ($120 / 12) of revenue has been earned and the deferred revenue amount is now $110. The accounting staff will transfer $10 from the deferred revenue account to the earned revenue account using the journal entry below: Debit Deferred Revenue $10 Credit Subscription Revenue ($10)
Using the previous example, at that time, the deferred revenue account will have a balance of $0, and $120 of revenue will have been recognized.
