What Deferred Revenue Is in Accounting, and Why It’s a Liability

When businesses receive advance payments, they don’t immediately record this money as revenue—instead, they treat it as a liability until they deliver the promised goods or services. Called deferred revenue, this approach ensures financial statements accurately reflect what the company owes and what it has genuinely earned.

In subscription-based industries with software services, prepaid service agreements, and professional retainers, deferred revenue can be a significant part of a company’s operations. For example, Microsoft Corporation (MSFT) reported about $60.18 billion in deferred revenue in 2024, illustrating the significant scale of future commitments to its customers.

Managing deferred revenue correctly is important since businesses need to plan the resources they will need. In addition, investors and managers rely on these accurate records to make informed decisions about a company’s health and potential growth.

What Is Deferred Revenue?

Deferred revenue, also called unearned revenue, is money a company receives upfront for goods or services it hasn’t delivered yet. It’s a core concept in accrual accounting, where revenue is recognized when earned, not necessarily when payments are received.

A business first records these upfront payments as liabilities because it owes customers the product or service. Only after fulfilling this obligation does the company recognize deferred revenue as income. This ensures financial statements accurately reflect what the company owes and what it has genuinely earned.

Characteristics of Deferred Revenue

Here are the main elements involved in deferred revenue:

• Payment in advance: This kind of revenue is only recorded when the customer pays the company before the goods or services are supplied. It could be for a subscription, service contract, product preorder, or any arrangement for later delivery.
• Liability classification: Initially listed as a liability, it remains on the balance sheet until the company delivers what the customer purchased.
• Recognized over time: Deferred revenue stays on the balance sheet as a liability until the company provides the service or product. As the company meets these obligations, it gradually moves deferred revenue to actual revenue on the income statement. This continues step-by-step until the company fulfills all obligations.

Why Deferred Revenue is Considered a Liability

Though its name includes “revenue,” deferred revenue is a liability in accounting terms. It is money the company has already received for goods or services it still needs to deliver.

Until the company fulfills its obligations, it owes customers the promised goods, services, or a refund. The company must return the customer’s payment if it can’t provide what’s owed. That’s why it’s a liability for accounting purposes.

Accounting Principles and Deferred Revenue

Deferred revenue reflects key accounting principles, ensuring financial transparency and accuracy. Under accrual accounting, companies recognize revenue when delivering goods or complete services, not receiving payments. This practice aligns directly with the revenue recognition principle—a fundamental part of GAAP. According to GAAP, revenue can only be recorded after it has been earned by fulfilling customer obligations.

Modern accounting standards like ASC 606 (U.S. GAAP) and International Financial Reporting Standards 15 reinforce this principle. These require businesses to record upfront payments as contract liabilities. Companies gradually convert these liabilities into recognized revenue as they complete their promised customer obligations.

Recognition and Reporting of Deferred Revenue

Deferred revenue starts when a company receives upfront payments for products or services it hasn’t yet delivered. At first, the business records this payment as cash (an asset) and simultaneously as deferred revenue (a liability).

The company progressively recognizes revenue as it delivers the promised goods or services. Each month, a part of the deferred revenue is moved into actual revenue for ongoing services like subscriptions. As this happens, the deferred revenue balance gradually reduces.

This process continues until the company fulfills all obligations and fully recognizes the revenue on its income statement. This method ensures that financial statements accurately represent the company’s actual earnings and outstanding obligations under GAAP.

Examples of Deferred Revenue

Deferred revenue commonly appears when companies collect payments before providing goods or services. Subscription-based software providers offer a clear illustration. For example, Adobe Inc. (ADBE) receives upfront payments for annual Creative Cloud subscriptions. However, Adobe initially records these payments as deferred revenue, gradually recognizing revenue each month as it provides continuous access to its products. 

Event organizers similarly experience significant deferred revenue. Companies such as Ticketmaster, a subsidiary of Live Nation Entertainment, Inc. (LYV), often sell tickets for events like concerts or sports games months in advance. Although the company collects the funds immediately, these funds remain deferred revenue until the events occur. 

Insurance companies also rely heavily on deferred revenue. When customers prepay premiums—like an annual auto insurance policy from State Farm Insurance—the insurer initially classifies payments as deferred revenue. Revenue recognition then occurs gradually, each month corresponding to the coverage provided.

Retailers like Amazon.com Inc. (AMZN) also use deferred revenue for their gift card sales.

Recognizing Deferred Revenue on Financial Statements

Deferred revenue significantly impacts how and when companies report revenue in their financial statements. When businesses receive upfront payments from customers, they initially record them as liabilities rather than immediate revenue. Revenue is then recognized gradually as the company delivers goods or services. This ensures financial statements reflect real business performance instead of merely cash inflows.

Besides influencing revenue timing, deferred revenue affects key financial metrics such as liquidity and leverage ratios. A high deferred revenue balance initially increases total liabilities, temporarily making the company seem more leveraged. As the business meets its obligations over time, these ratios stabilize, providing stakeholders with a more precise and more accurate view of the company’s overall financial health.

Deferred revenue also helps companies accurately measure profitability over specific periods. Without deferring revenue, companies might incorrectly inflate profits during periods of high upfront payments. By aligning revenue recognition with actual service delivery, deferred revenue allows businesses to avoid overstating profits and provides a realistic view of financial results.

In addition, deferred revenue improves financial transparency, helping investors and analysts assess future business potential. A substantial deferred revenue balance indicates strong future earnings but also shows the obligations still awaiting fulfillment. Clearly presenting these obligations allows stakeholders to accurately assess a company’s long-term financial position and future performance.

Case Study: Subscription-Based Business Model

Adobe provides a good example of how companies account for deferred revenue from subscriptions. In fiscal year 2024, Adobe generated $20.52 billion in revenue from subscriptions. Many of its customers typically pay upfront for annual access to services like Adobe Creative Cloud, resulting in significant deferred revenue.

When Adobe receives these upfront payments, it initially records them as deferred revenue—a liability on its balance sheet. The amount remains a liability because Adobe must still deliver services throughout the subscription period. As customers use the services monthly, Adobe gradually converts deferred revenue into earned revenue, reducing the liability balance. Below are the relevant sections from its 2024 consolidated balance sheets in its 10-K report to the SEC:

The Bottom Line

Using deferred revenue is not just about accounting compliance—it provides businesses with an accurate picture of what a company has actually earned versus what it still owes customers. By matching revenue recognition with service delivery, companies create realistic financial projections that lead to more informed business decisions.