What is a Deferred Liability?

Deferred Liability

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Deferred Liability

A deferred liability, also known as a deferred credit or deferred revenue, refers to money received by a company for goods or services that it has not yet delivered or performed. In other words, it’s a liability because the company still owes the goods or services to the customer.

When a company receives payment in advance, it records the amount as a deferred liability on its balance sheet, under the liabilities section. This represents an obligation to deliver goods or perform services in the future.

As the goods are delivered or the services are performed, the deferred liability is reduced and the amount is recognized as revenue on the income statement.

For example, if a software company receives an upfront payment for a one-year subscription, it records the payment as a deferred liability. Each month, as it provides the service, it reduces the deferred liability and recognizes an equivalent amount as revenue.

By the end of the year, all the deferred liability will have been recognized as revenue, assuming the company fulfills its obligation to provide the service for the full year.

Example of a Deferred Liability

Let’s consider an example of a deferred liability using a magazine subscription.

Suppose a magazine publisher offers a one-year subscription for $120, and a customer decides to purchase it. The customer pays the full amount of $120 upfront. At this point, the magazine publisher has received the payment but has not yet delivered any issues.

The publisher would record this payment as a deferred liability on its balance sheet because it still has an obligation to deliver the magazines over the next 12 months:

Dr. Cash $120
Cr. Deferred Revenue (Liability) $120

Now, let’s assume the publisher delivers a magazine each month. After delivering the first issue, the publisher has fulfilled 1/12 of its obligation, so it can recognize 1/12 of the $120 as revenue:

Dr. Deferred Revenue (Liability) $10
Cr. Subscription Revenue $10

This process continues for each subsequent month. By the end of the 12-month subscription, the entire deferred liability of $120 will have been recognized as revenue, as the publisher has fulfilled its obligation to deliver all the magazines in the subscription:

Total Subscription Revenue recognized over 12 months: $120 Deferred Revenue (Liability) remaining: $0

This example demonstrates how deferred liabilities are used to properly match revenues with the corresponding expenses and performance obligations in the accounting records.

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