What is Deferred/Unearned Revenue, Journal Entry and Impact on Reports

Hello everyone. In today's tutorial we are going to take a look at deferred revenues, deferred sales, also referred to as unearned revenues or unearned sales. My name is Ronica Kenna. I am a CPA and a CFA and the founder of Montreal Financial, where you can find lots of resources for small business and solopreneurs and sign up for my newsletter. Okay, so what exactly is a deferred or unearned revenue? Very simply speaking, a deferred or unearned revenue is one for which you have received payment or you have invoiced your customer, but you haven't actually performed the services or delivered the product yet. And therefore you do not want to reflect this as sales since it would be inaccurate in terms of your total sales on your profit and loss. It would overestimate your sales number and your profit number. So we want to have a mechanism to remove any sales that have not actually occurred. This is also part of Generally Accepted Accounting Principles, or gaap, which says that revenues or sales are only recognized once the product or service has been delivered. So for the purposes of this tutorial, I am going to use the example of a subscription payment. This is perhaps one of the most common types of deferred revenues and I think it makes sense to look at that. But keep in mind that this journal entry that I am going to show you applies to any type of unearned or deferred revenue. You simply have to ensure that the amount that you are reflecting as unearned revenues is the amount of the sale that has not yet been completed.

So for these purposes I always like to use the Sherlock Holmes Detective Agency and let's assume that they sell a magazine and you can purchase the magazine monthly or you can get an annual subscription. The annual subscription costs $240 a year. And in this case the sale that you made was to a customer who purchased it in October of 2024. So the subscription will run out in September of 2020 25. So first of all, let us just set up the subscription amount. We'll go to invoices.

And let's create an invoice.

The customer in this case is going to be Scotland Yard. They like to keep abreast of everything that Sherlock Holmes is doing. The invoice date in this case is October 1st, and the product or service is a. We're just going to put in magazine. So we don't have magazine here. I can simply add it. I'm going to add it as a service and the income account is going to be product sales. You can set up a new account here if you'd like to more accurately reflect what the product is. But this is just for illustration purposes, so we're not really looking at this other stuff. We are going to charge this customer HST in Ontario. So I will save and close this and then I am going to close. So in the description column, I'm going to put October 2024 to September 2025. So the quantity is 1 and $240. The quantity could also be 12 because they get a monthly subscription. And I put $240 HSC Ontario is automatically applied. So the total amount of the invoice is $271.20. So I'm going to save and close this because this is how you would enter the invoice exactly as you would enter a normal invoice. Now the next step is to determine what portion of this $271 is deferred revenues. So again, if we take a look at the invoice, you'll see the total amount is $240. The tax. I am not going to make an adjustment to the tax amount because we are collecting the full amount of tax. So we will remit the full amount of tax to the the government. We are simply going to show a portion of the $240 as unearned. And essentially we are going to be doing the unearned revenue at December 31st. So we have three months of the subscription that has been earned and then nine months that has not been earned. Okay, so let's create a journal entry to show that. I'm going to click on + new click on journal entry. And then the date of the journal entry is going to be December 31, 2024. And I am going to set up a new account called Deferred Revenue.

And this directly takes me to the chart of accounts. In this case, deferred revenue is an other current liability because I expect this to be resolved within the next year. And that is the definition of current liabilities, an amount that in essence that you owe or have not earned. We're going to choose other current liabilities and then the detail type is current liabilities. They don't really have an unearned revenue or deferred revenue. Over here we will call this account Deferred Revenue.

For the default tax code, I am simply going to use out of scope. It does not apply in this case. Anytime you use this account, it will use the out of scope default tax code. Let's save and close. Now we know that we have $240.

Of. But you will have to enter the account again. Okay, so we know that we have $240 of a total sale to Scotland Yard. But we also know that of the 12 months that they pay for, nine months relate to next year. And this is assuming your fiscal year is December 31st, you can use whatever fiscal year applies in your situation. And you can also do this monthly. This is in a year end entry in my case. But you can also set up the deferred revenue and reverse it every month. And I will show you how to reverse it shortly. So we're going to divide this by 12 when you can do this directly. Here I have another video on how to just do calculations directly in the field. It's a very handy feature. You click out of the field and then it gives you. So this is $20 per month. And nine months of this is going to be deferred or unearned. So let's multiply it by nine, click out of the field and we have $180. Now it is a credit because anything that is a liability liability under a liability or equity section of the balance sheet is a credit because it is an increase in a liability amount. So we're going to enter this as $180. And then in our description we can say to reflect portion of subscription.

That is unearned.

One or the other is fine. And for the name we can simply select Scotland Yard. Sales tax is not applicable. You don't have to enter this. So that is the credit amount and the debit amount in this case. You'll recall that when we set up magazine subscription, we use product sales as the account to which the magazine subscription relates. So I want to reduce the sales amount of the product sales by the exact same.

Amount. So I'm going to choose product sales for $180. It automatically enters both the description, which is fine, and the $180. So December 31st and that's it. So that is the entry to reflect the deferred revenue. So we're going to save this. Okay, so we have our entry and now I want to put this back into income for 2025. And the way to do this is simply to reverse the entry. So I click on reverse here, bottom middle of those black bar. And it automatically creates a reversal on January 1, 2025. And the reason I do it this way is I don't have to touch the invoice. The invoice Remains the same. But from an accounting perspective, I am able to show that the sales of $180 actually belong to next year. So I take it out in 2024, I reduce the sales in 2024, and then I add the sales back to 2024. If you wanted to do this monthly, we know that it's $20 per month. You could simply add this back. You could Change this to $20.

And then enter it on January 31st and so on. At the end of every month, I'm going to change this back to 180 because I only do this once a year for my accounting and tax purposes. And then I save and close. And let's just quickly take a look. We're going to go to reports.

And I'm going to show it to you on both the balance sheet and the profit and loss statement. So let's take a look at the balance sheet. So now I want to show this as of December 31st. So I am going to choose this calendar year because the fiscal year end for the Sherlock Holmes detective agency is November 30th. But I want to see the entry at December 31st. So I go here, I look at deferred revenue and you'll see my liabilities have increased by $180. I'm going to click on this and then I also want to see the reversing entry. So I click on January 31st under the custom date run report and you can see that it's been reversed and there's nothing left in this account. Similarly, I'm going to go to reports.

And I'm going to go to the profit and loss statement. So I'm going to go to the product sales. Click on that and you will see here, this is my original invoice for $240, which is adding to the sales amount and then the $180, which reduces the $240. So I'm only showing $60 of sales in 2024. Now if I change this to 2025 and I run report, you'll see I already have $180 of sales relating to 2025. This is in a positive position. So my total sales amount is 180 for 2025. So this is how deferred or unearned revenues works in a nutshell. Again, you can use this exact treatment for any type of unearned revenue and simply enter a journal entry to adjust the amount on the invoice. Or if you have several invoices, you can do the same thing. In that case, I recommend using Excel Schedule. You can export all your invoices to an Excel Schedule, do a calculation of the amount that is deferred or unearned, and then enter it as a journal entry and then reverse the journal entry for the future for the following period. I hope this is helpful. If you have any any questions, don't hesitate to leave a comment and I'll be happy to answer it. And please like and subscribe and sign up to my newsletter. Have a great day.