What Is Deferred Income? A Simple Guide for Businesses
Updated on October 3, 2025 | 8 min. read
🌟 KEY TAKEAWAYS
Deferred income (aka deferred revenue or unearned revenue) is money you’ve collected before you’ve earned it—typical with upfront payments in subscription-based businesses and other prepayment models.
On the balance sheet, it's recorded as a liability (a deferred revenue liability)—not as revenue. On the income statement, it's recognized as revenue over the subscription period or service delivery.
Properly recognizing deferred revenue using the accrual accounting method (GAAP’s revenue recognition principle) keeps your financial statements accurate and your financial reporting transparent.
Common deferred revenue examples: annual subscription payments (SaaS/software company), retainer fees (legal/consulting), and gift cards (recognized when redeemed).
Imagine your business receives a large order for your services over the upcoming year, with payment up front. Cha-ching, you've got the money in your account, but the question is, have you really “earned” that money yet?
In the accounting world, you haven't. It's called deferred revenue (also called deferred income or unearned revenue): payment received for goods or services that have not yet been delivered or rendered.
In this guide, we’ll explain the concept of deferred revenue in detail, demystifying this important financial concept and explaining its critical role in accurate financial reporting. Let’s take a look!
What is deferred income (deferred revenue)?
Deferred income (also called deferred revenue or unearned revenue) is money you’ve collected before you’ve earned it. Until you deliver the goods or services, it sits on your balance sheet as a liability, which is a promise you still owe to your customer. That’s the accrual-accounting way: Revenue is recognized when it’s earned, not when cash hits the bank.
Think of it like this: cash in now, revenue later. It keeps your financial statements honest about what’s been earned vs. what’s still on your to-do list. This is a core concept in the accrual accounting system, which only recognizes revenue when it’s earned, not necessarily when it’s received.
By treating deferred revenue as a current liability rather than considering it normal revenue right away, you ensure accurate financial statements that reflect what your company has actually earned versus what it genuinely owes.
Essentially, deferred income is a promise to your customer. It represents a future obligation of goods or services that you must fulfill.
There are some businesses that have deferred revenue as a significant part of their financial operations. Subscription-based businesses, software companies, and businesses that operate on retainer all rely on deferred revenue. For these industries, a strong approach to deferred revenue accounting is essential. By managing this type of income properly, you’ll be able to better plan your future needs, as well as make more informed decisions about the future growth of your company.
How deferred income works: the accounting mechanics
To better understand accounting for deferred revenue, here's an example. Let’s say you run a company that sells software subscriptions. The process of accounting for deferred revenue would be as follows:
- Cash received: A customer pays $1,200 upfront for a 12-month subscription to your software, and you receive the full amount in your bank account.
- Initial journal entry: In your accounting journal, you’d make the following entries: Debit cash for $1,200 and credit deferred revenue for $1,200. Because the client has not received their entire 12-month subscription yet, these funds are listed as a liability, since you still need to provide the remainder of the goods they’ve paid for.
- Recognizing revenue over time: Each month, as you continue to provide the software that your customer paid for, you will gradually adjust the revenue. In the case of our example, you would adjust it with one entry per month of $100, debiting deferred revenue ($100) and crediting service revenue ($100), and continue until the goods or services have been completely delivered. This is known as revenue recognition in the accrual accounting method.
- End of period: At the end of your accounting period, your deferred revenue liability will have decreased by the number of months that have elapsed since the initial purchase, while your revenue will have increased by the same amount. This process continues until the client’s 12-month subscription period is over, at which point deferred revenue will be $0, and the full $1,200 will have been recognized as revenue, since you have fulfilled your entire obligation to the customer.
Why does deferred income matter?
Now that we understand a bit more about how deferred revenue works, let’s learn about why it’s important. Here are the most important reasons to account for deferred revenue in your accounting process:
- Accurate financial reporting: Accounting for deferred revenue ensures adherence to the revenue recognition principle and Generally Accepted Accounting Principles (GAAP) standards.
- Financial health, at a glance: Deferred revenue is your “promises in progress.” Tracking it shows what you still owe customers and hints at demand. A bigger balance often signals a healthy pipeline—especially for SaaS and other subscription businesses that collect upfront payments.
- Cash in the bank ≠ profit: Prepayments boost cash flow today, but they’re not earned revenue until you deliver. Keeping cash and profit separate (hello, accrual accounting and revenue recognition) helps you plan, spend, and stay on top of those obligations to customers.
Confidence for investors: Analysts and investors watch deferred revenue to gauge future performance and stability. Clean, consistent recognition in your accrual system builds trust, making fundraising, credit, and board conversations much easier.
Real-world examples of deferred income
Now for the practical bit: common real-world deferred revenue examples and why each industry leans on them for clean, trustworthy financial statements.
Industry | Example | How it Works |
|---|---|---|
Software (SaaS) | annual subscription fee | A company pays for a 1-year license. Revenue is recognized monthly. |
Publishing | magazine subscription | A reader pays for a 12-month subscription. Revenue recognition occurs as each issue is delivered. |
Retail | gift cards | A customer buys a $100 gift card. It's deferred revenue until the card is redeemed for goods or services. |
Legal/Consulting | retainer fee | A client pays a monthly retainer for services on demand. Revenue recognition happens as hours are worked or at the end of the month. |
Airlines | plane tickets | A passenger buys a ticket for a future flight. It's deferred revenue until the flight occurs. |
Where does deferred revenue live on the balance sheet?
Deffered revenue appears on your company's balance sheet, right in Liabilities. Because deferred revenue (aka unearned revenue or deferred income) is money you’ve collected but haven’t earned yet, it shows up as a liability until you deliver.
Quick guide:
- Where you’ll see it: Liabilities; often in Current Liabilities (any long-tail portion can sit in Noncurrent Liabilities)
- What it might be called: Unearned Revenue, Deferred Revenue, Deferred Income, or Contract Liability
- What it sits beside: accounts payable, long-term debt, and lease liabilities
- When it moves: As you deliver goods or services, you reduce deferred revenue and record recognized revenue on the income statement. That’s revenue recognition doing its thing.
A real-world peek:
Public companies commonly present deferred revenue this way in their annual reports. For example, this annual report from Alphabet (Google’s parent) shows deferred revenue in the liabilities section—no surprise for businesses with subscriptions, software, and other prepaid services.
Wrap-up: make deferred revenue easy (and accurate)
Deferred revenue is simple once you see the logic: It’s payment received now for goods or services you’ll deliver later, so it sits on the balance sheet as a liability. Under modern accounting standards like GAAP and IFRS, it's labeled a "contract liability" because it represents a contractual obligation to your customer.
As you deliveron that those goods or services, you recognize revenue on the income statement. That keeps your financial statements honest and your business’s financial health clear.
Here’s the tidy version:
- What it is: upfront payments you haven’t earned yet are deferred revenue (a liability)
- How it's recorded: As value is delivered over time, move the corresponding slice each period from deferred revenue on the balance sheet to revenue on the income statement (that’s revenue recognition under accrual accounting).
- Why it matters: prevents inflated profit, leads to cleaner decisions, improves planning, makes investors/lenders happy, means fewer surprises at tax time
- One small nuance: If the obligation runs past 12 months, split it into current and noncurrent liabilities on the balance sheet.
How to handle it in FreshBooks
- Create a liability account: In your chart of accounts, create an account called Deferred Revenue (or Contract Liability, the modern GAAP/IFRS term).
- When the cash comes in: Record the cash payment and credit Deferred Revenue, not Revenue.
- Each period (month/quarter): Post a simple journal entry to debit Deferred Revenue and credit Revenue for the earned portion.
- Run the reports: The Balance Sheet report shows what you still owe, the Profit and Loss report (the income statement) shows what you actually earned, and the Cash Flow report shows when cash arrived.
- Document the schedule: If it’s a 12-month subscription, keep a quick schedule so the deferred revenue balance always ties to your delivery.
Note: This is general guidance, not tax advice. If you’ve got edge cases (refunds, breakage on gift cards, multi-year contracts), loop in your accountant for their advisory services.
Ready to keep it buttoned-up?
FreshBooks helps you keep accurate records, recognize revenue on time, and see your company’s financial position at a glance. Track upfront payments, post clean journal entries, and run the reports you need—without spreadsheet gymnastics.
Try FreshBooks free and make revenue recognition one less thing to worry about.
Frequently asked questions
Still have questions about accounting for unearned revenue or the importance of deferred revenue? Get the answers you need with these frequently asked questions.
Is deferred income the same as accounts receivable?
No. They’re opposites. Accounts receivable is an asset on your balance sheet, representing earned revenue you’ve invoiced for but haven’t collected yet. Deferred income (aka deferred revenue or unearned revenue) is a liability on your balance sheet, for cash payments you received upfront for goods or services that you’ll deliver at a future date.
Where does deferred revenue show up in my financial statements?
On your company’s balance sheet under Liabilities (may show as Deferred Revenue, Deferred Income, or Contract Liability). As you deliver service each month of the subscription period, you move a slice from the deferred revenue account to recognized revenue on the income statement. Your cash flow statement already showed the cash inflow when the customer paid.
Is deferred income good or bad for my business’s financial health?
It’s usually a good signal. A healthy deferred revenue balance can point to strong demand (think SaaS company with lots of annual subscription payments received). Just remember: It’s still a liability and evidence that the company owes delivery. Managing it cleanly boosts financial transparency, financial reporting, and the overall company’s financial health.
Do I pay income taxes when cash comes in or when revenue is recognized?
It depends on your tax accounting method. If you use the accrual method, you generally pay when revenue is recognized, not when cash is collected. If you use the cash method for accounting, you'll likely pay taxes when cash is received. Translation: Talk to a tax pro so your tax bill timing matches the facts of your business.
What happens if the service is never delivered?
You typically refund the customer. That reduces the deferred revenue liability (and cash), and you don’t recognize revenue. If only part is undelivered, you recognize what was earned and unwind the rest. Talk to your accountant and follow your accounting process and accounting principles.
