Unearned revenue vs. deferred revenue: Key accounting differences

SaaS is the largest segment of the public cloud services market, with spending projected to grow 20% to $247.2 billion in 2024. 

This growth is fueled by businesses adopting SaaS solutions and paying for subscriptions upfront, underscoring the importance of accurately understanding and managing deferred and unearned revenue.

In this article, we'll explain the key differences between unearned and deferred revenue. We’ll also explore their nuances and implications for financial reporting.

You'll also learn:

• How to accurately track and manage deferred and unearned revenue.
• The impact of these concepts on your financial statements.
• Best practices for ensuring compliance with revenue recognition standards.
• How Orb, the billing platform built for SaaS, can simplify your revenue management.

Before we explain the difference between unearned revenue vs. deferred revenue, let’s explain each concept. 

What is unearned revenue?

Unearned revenue is money a business receives before it delivers goods or services. In other words, it's cash received for a promise to deliver something in the future. 

It's closely related to the term “deferred revenue,” but with a slight distinction. Unearned revenue typically refers to payments expected to be earned within a year. Deferred revenue can encompass both short-term and long-term obligations.

We’ll explain the key differences later in this article, but this is one key distinction between unearned and deferred revenue to make note of. 

Accountants aim to ensure that revenue is reported in the financial statements when it's actually earned – that's where unearned revenue comes in. It helps companies keep track of upfront payments and recognize them as revenue at the right time.

Is unearned revenue a liability? 

The answer is a resounding yes. It represents an obligation the company has to its customers. It's like an IOU — the business owes its customers something in the future.

Unearned revenue pops up in all sorts of industries. Here are a few examples:

• Subscription services: Imagine you prepay for a year of Netflix. Now, Netflix receives your payment upfront, but they haven't actually "earned" it until they provide you with a year's worth of streaming.
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• Insurance: When you pay your car insurance premium in advance, the insurance company has unearned revenue. They haven't provided the full coverage yet.
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• Gift cards: That gift card you bought for your friend? The retailer has unearned revenue until your friend redeems it.
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• Software licenses: Many SaaS companies offer annual subscriptions. The upfront payment is unearned revenue until the software access is provided throughout the year.

What is deferred revenue?

Deferred revenue is an accounting term for payments received in advance for goods or services that have not yet been delivered or rendered. 

It represents a company's obligation to fulfill a future commitment to its customers. While sometimes considered the same as unearned revenue, it's crucial to note that there are subtle differences between the two. As stated before, we’ll explain those differences in a later section.

Why is deferred revenue recorded as a liability? 

It all comes down to accounting principles. Like with unearned revenue, accountants want to make sure that revenue is recognized only when it's actually earned. Until the goods or services are delivered, that upfront payment represents a liability on the balance sheet.

Deferred revenue is classified as a current liability if the goods or services will be delivered within a year. If the obligation extends beyond a year, it becomes a long-term liability.

Where does deferred revenue show up? 

You'll often find it in businesses with subscription models or those that receive advance payments. Here are a couple of examples:

• SaaS companies: Imagine a SaaS company that offers annual subscriptions. The upfront payment from users is deferred revenue. Each month, as the company provides access to the software, a portion of that deferred revenue becomes earned revenue.
• Subscription boxes: Those monthly boxes of goodies you receive? The company likely has a good chunk of deferred revenue on its books. They've been paid upfront, but they need to deliver those boxes of goodies before they can truly call it "earned" revenue.

Deferred vs. unearned revenue: Key similarities 

It's easy to get tripped up by the terms deferred revenue and unearned revenue. They often get used interchangeably, and it's easy to see why. Both revolve around a core idea that a business receives payment before delivering the related goods or services.

What do they have in common?

Let’s take a closer look at their key similarities:

• Both represent an obligation. Whether you call it deferred or unearned revenue, the company owes its customers something. It has a commitment to provide goods or services in the future.
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• Both are recorded as liabilities. This is a fundamental similarity. Until those goods or services are delivered, the upfront payment represents a liability on the balance sheet.
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• Both impact financial reporting. Accurately accounting for these payments, regardless of the specific term used, is crucial for compliance with accounting standards and for providing a true picture of a company's financial health.

Why is it so important to get this right?

When it comes to unearned revenue vs. deferred revenue, accurate reporting is vital for:

• Maintaining transparency: It provides a clear and honest view of a company's financial position.
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• Building trust: Accuracy fosters confidence among investors and other stakeholders.
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• Making informed decisions: It allows for sound financial planning and analysis.

While we'll explore their key differences in the next section, it's crucial to recognize these fundamental similarities first. Both deferred and unearned revenue highlight the importance of recognizing revenue at the right time and adhering to sound accounting principles.

Unearned revenue vs. deferred revenue: Major differences 

While often used interchangeably, there are some key distinctions between unearned revenue and deferred revenue. Let's break down these differences into three key areas:

1. Usage in accounting contexts

Both terms refer to advance payments for goods or services not yet delivered. However, there are subtle differences in how accountants use them. Let’s explain those differences:

• Unearned revenue: This term typically focuses on the short-term obligations a company has to its customers. Think of it as payments expected to be earned within the next year.
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• Deferred revenue: This is the broader term, encompassing both short-term and long-term obligations. It provides a more complete view of all advance payments, regardless of when they are expected to be earned.  

Think of it this way: Unearned revenue is a subset of deferred revenue. It's the portion of deferred revenue that's expected to be recognized as earned revenue in the near future.

Unearned revenue vs. deferred revenue: The choice of which term to use often depends on the context and the company's accounting practices. Some companies might use unearned revenue for all advance payments. Others might differentiate based on the time horizon.  

2. Timing and recognition

Another key difference lies in how these terms relate to the timing of revenue recognition. Let’s zoom in:

• Unearned revenue: It’s often associated with shorter-term obligations. It applies to instances where the revenue is expected to be earned relatively quickly. Think recurring payments or subscriptions with shorter billing cycles.  
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• Deferred revenue: This type can encompass longer-term contracts. Think of situations where revenue recognition might be spread out over several months. This approach is common in industries like SaaS, where projects or service delivery can span extended periods.  

The distinction here highlights the importance of matching revenue with the delivery of goods or services. Whether it's unearned or deferred revenue, the key is to recognize it in the accounting period when it's actually earned.

3. Impact on financial statements

Both unearned and deferred revenue impact a company's financial statements. The difference is they might appear in different sections. Let’s explain what we mean here:

• Unearned revenue: It’s typically classified as a current liability on the balance sheet. Why? Because it's expected to be earned within the next year. As the revenue is earned, it's moved from the liability section to the revenue section on the income statement.  
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• Deferred revenue: It might be split between current and long-term liabilities on the balance sheet. How it’s split will depend on when the revenue is expected to be earned. The portion related to longer-term obligations would appear under long-term liabilities.

Understanding these nuances is crucial for accurate financial reporting and analysis. It allows stakeholders to get a clear picture of a company's obligations and its future revenue streams.

How to manage unearned and deferred revenue in SaaS

Here's a breakdown of how SaaS companies can keep things running smoothly:

1. Set up accurate tracking

First, you need a system that accurately tracks all those incoming payments and ties them to specific customer subscriptions. Here are a few tips for doing that:

• Detailed records: Keep records of each customer, their subscription plan, the payment amount, and the payment date. 
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• Automation is your friend: Consider using a billing platform. These platforms can automate a lot of the heavy lifting, including invoice generation, payment processing, and revenue recognition schedules.
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• Separate accounts: Keep separate accounts for unearned and deferred revenue. This is especially useful if you offer subscriptions with different billing cycles.

2. Implement real-time reporting

Real-time reporting can provide invaluable insights into your financial health. Let’s see how it helps with handling both unearned and deferred revenue:

• Dashboard visualization: A good billing platform will often have dashboards that show your key metrics. These key metrics should include unearned and deferred revenue.
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• Customizable reports: You should be able to generate reports that show you exactly what you need to know. Reports should show you revenue recognized over a specific period or a breakdown of deferred revenue by subscription plan. 
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• Integrate with accounting software: Integration with your accounting software will make it much easier to reconcile your data. It can also help you make sure everything is up to date.

3. Monitor for compliance with revenue recognition standards

Staying compliant with accounting standards is non-negotiable. Here are a few pointers to keep in mind:

• Understand the rules: Familiarize yourself with the relevant accounting standards for revenue recognition. One of them is ASC 606. Standards provide guidelines on when and how to recognize revenue from customer contracts.
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• Regular reviews: Conduct regular reviews of your revenue recognition processes. Reviews might involve internal audits or consultations with accounting experts.
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• Stay updated: Accounting standards can change, so it's important to stay informed about any updates or revisions.

Orb assists you in managing deferred and unearned revenue

We've explored the nuances of unearned revenue vs. deferred revenue. We’ve also highlighted their importance for proper financial reporting and compliance. 

Now, the question is: How can you effectively manage subscription complexity in your SaaS business?

Orb is a done-for-you billing platform. It can simplify this process and allow you to take control of your revenue streams.

Here's how Orb can simplify your deferred and unearned revenue management:

• Accurate revenue recognition: Orb's usage tracking and metering infrastructure are key features. They ensure that revenue is recognized accurately based on actual product usage and consumption or service delivery. 
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• Reporting and dashboards: Gain fresh visibility into your deferred and unearned revenue with Orb's dashboards. Track key metrics, spot trends, and make informed decisions about your financial strategy.
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• Clear and transparent invoices: Orb generates detailed invoices that reflect customer subscriptions and usage.
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• Simplified compliance: Orb's features help you adhere to revenue recognition standards. We do so by automating revenue schedules and providing detailed audit trails.
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• Flexible subscription management: Orb supports many subscription models and pricing structures. We allow you to tailor your offerings to your customers' needs and optimize your revenue streams.
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• Tech stack integration: Orb integrates with your existing data warehouses and accounting software. We streamline your billing operations and reduce manual effort.

Ready to simplify your deferred and unearned revenue management? Give Orb a try with our 30-day free trial and discover how it can transform your revenue management. Check out our flexible pricing options to find a plan that aligns with your business needs.