Deferred Revenue vs. Expenses: Why They Matter for Profitability

Deferred revenue and expenses can significantly impact how your financial performance appears — especially under accrual accounting.

Under the accrual basis of accounting, recording deferred revenues and expenses can help match income and expenses to when they are earned or incurred. This helps business owners more accurately evaluate the income statement and understand the profitability of an accounting period.

While these concepts are often taught as accounting fundamentals, they also directly affect how business owners and finance teams evaluate profitability, cash flow, and overall performance.

Below we define deferred revenue and expenses, how they are recorded, and why they matter when evaluating financial performance.

Defining Deferred Revenue and Deferred Expenses

Deferred revenue is money received in advance for products or services that are going to be performed in the future. Rent payments received in advance or annual subscription payments received at the beginning of the year are common examples of deferred revenue.

Deferred expenses, similar to prepaid expenses, refer to expenses that have been paid but not yet incurred by the business. Common prepaid expenses may include monthly rent or insurance payments that have been paid in advance.

Accounting for Deferred Revenue

Since deferred revenues are not considered revenue until they are earned, they are not reported on the income statement. Instead they are reported on the balance sheet as a liability. As the income is earned, the liability is decreased and recognized as income.

Here is an example for a $1,000 payment for services that have not yet been performed: In this transaction, the Cash (Asset account) and the Unearned Revenue (Liability account) are increasing.

Once the services are performed, the income can be recognized with the following entry: This entry is decreasing the liability account and increasing revenue.

Why is deferred revenue considered a liability? Because it is technically for goods or services still owed to your customers.

For example, a SaaS company receiving annual subscription payments upfront may appear highly profitable in one period. However, without properly accounting for deferred revenue, that financial picture can be misleading.

Accounting for Deferred Expenses

Like deferred revenues, deferred expenses are not reported on the income statement. Instead, they are recorded as an asset on the balance sheet until the expenses are incurred. As the expenses are incurred the asset is decreased and the expense is recorded on the income statement.

Below is an example of a journal entry for three months of rent, paid in advance. In this transaction, the Prepaid Rent (Asset account) is increasing, and Cash (Asset account) is decreasing.

Once one month of the expense has been incurred, the expense can be recognized with the following entry: Here we are decreasing our Prepaid Rent and increasing our Rent Expense on the income statement.

Under the cash basis of accounting, deferred revenue and expenses are not recorded because income and expenses are recorded as the cash comes in or goes out. While this approach is simpler, it can make it more difficult to accurately evaluate profitability and financial performance over time.

If you’re reviewing financial statements and unsure how timing differences like deferred revenue impact profitability, gaining clarity on these concepts is a critical first step.

Learn more about choosing the accrual vs. cash basis method for income and expenses.