Question

Question 1

On December 15, 2015, a public company receives an order from a customer for services to be performed on December 28, 2015. Due to a backlog of orders, the company does not perform the services until January 3, 2016. The customer pays for the services on January 6, 2016. When should revenue be recorded for the company? Why (support your argument with a principle from the textbook)?

Answer 1

1) In this problem,the collected money from customer is treated as advance until the company performing the work.

The term advances from customers refers to money collected by a company prior to providing a product or service. Advances from customers are oftentimes collected when businesses sell prepaid subscriptions or gift certificates.

When companies collect this money, the intention is to eventually provide the product or service paid for by the customer. Following the receipt of this cash, the company would classify the advance as a current liability on the balance sheet.

Current liabilities are defined as debts that must be paid within one year or one operating cycle, whichever is longer. When a customer pre-pays for a product or service, this transaction becomes part of a larger group of liabilities from advanced collections, which is a component of the company's definitely determinable liabilities, since it's both known to exist and can be measured precisely.

Advances from customers are commonplace in the airline, magazine or newspaper industries, whereby the customer usually pays for a seat on a plane, or a magazine subscription, prior to receiving the publications or flying on the airplane. Gift certificates, also known as gift cards, are another common arrangement that involves the collection of money in advance of providing a product or service.

When a company collects this money from a customer, there is an increase to cash and a corresponding increase to the current liability unearned revenue. When the product or service is rendered, the balance in unearned revenue decreases, and there is a corresponding increase to revenues.

Under the accrual method of accounting, when a company receives money from a customer prior to earning it, the company will have to make the following entry:

• Debit Cash
• Credit a liability account such as Deferred Revenue, Deferred Income, Unearned Revenue

The credit to the liability account is made because the company has not yet earned the money and the company has an obligation to deliver the goods or services (or to return the money) to the customer. Accountants will state that the company is deferring the revenue until it is earned. Once the money is earned, the liability will be decreased and a revenue account will be increased.

In terms of debits and credits, the company receiving the money in advance will debit the asset account Cash and will credit a liability account such as Unearned Income, Unearned Revenues, Deferred Income, Deferred Revenues, Customer Deposits, etc. Let's assume that the credit is made to Deferred Income.

KEY TAKEAWAYS

• Deferred revenue is a liability on a company's balance sheet that represents a prepayment by its customers for goods or services that have yet to be delivered.
• Deferred revenue is recognized as earned revenue on the income statement as the good or service is delivered to the customer.
• The use of the deferred revenue account follows GAAP guidelines for accounting conservatism.
• If the good or service is not delivered as planned, the company may owe the money back to its customer.

When the company provide the service to the customer,that time that income is treated as revenue.

For example, suppose a business provides web design services and invoices for annual maintenance of 12,000 in advance. At the time of invoicing the service has not been provided and the service revenue has not been earned, it therefore needs to be credited to the deferred revenue account.

The accounting records will show the following bookkeeping entries for the web design maintenance services invoiced in advance:

Deferred Revenue Journal Entry

Account	Debit	Credit
Accounts receivable	12,000
Deferred revenue account		12,000
Total	12,000	12,000

Deferred Revenue Journal Entry

A deferred revenue journal entry is needed when a business supplies its services to a customer and the services are invoiced in advance.

For example, suppose a business provides web design services and invoices for annual maintenance of 12,000 in advance. At the time of invoicing the service has not been provided and the service revenue has not been earned, it therefore needs to be credited to the deferred revenue account.

Deferred revenue is sometimes referred to as unearned revenue.

The deferred revenue journal entry will be as follows.

Deferred Revenue Journal Entry

The accounting records will show the following bookkeeping entries for the web design maintenance services invoiced in advance:

Deferred Revenue Journal Entry

Account	Debit	Credit
Accounts receivable	12,000
Deferred revenue account		12,000
Total	12,000	12,000

Deferred Revenue Journal Entry Bookkeeping Explained

Debit
The customer owes the business the money for the services until they are paid for. The business now has an asset (trade accounts receivable or trade debtor) for the amount due.

Credit
The service has not yet been provided to the customer and the service revenue is not treated as recognized revenue, it is credited to the balance sheet deferred revenue account until earned.

The accounting equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities plus the total equity of the business This is true at any time and applies to each transaction. For this transaction the accounting equation is shown in the following table.

In this case one asset (accounts receivable) increases representing money owed by the customer, this increase is balanced by the increase in liabilities (deferred revenue account). The credit to the deferred revenue account represents a liability as the service still needs to be provided to the customer.

Deferred Revenue Recognition

Deferred revenue recognition will happen as soon as the service is provided.

In the above example, the maintenance contract costs 12,000 for 1 year, assuming the business produces monthly management accounts, each month 1,000 will be become recognized revenue and credited to the services revenue account in the income statement with the following journal entry

Journal Entry for Deferred Revenue Recognition

Account	Debit	Credit
Deferred revenue account	1,000
Service revenue account		1,000
Total	1,000	1,000

At the end of 12 months all the deferred revenue (unearned revenue) will have been taken to the service revenue account (earned revenue).

Thanking you............!