Demystifying Revenue Deferral: A Step-by-Step Guide

Revenue deferral is a crucial accounting practice that enables businesses to accurately reflect their financial performance over time (accrual), especially in industries where services are rendered, or products are delivered over extended periods. In this blog post, we'll delve into the step-by-step process of deferring revenue, focusing on key actions like creating estimates, generating invoices, and handling deposit-retainers (unearned revenue).

Step 1: Create an Estimate (Non Posting)

The journey to revenue deferral begins with creating a detailed estimate outlining the scope of the project, anticipated costs, and the timeline for completion. This estimate serves as a blueprint, providing a solid foundation for subsequent financial transactions.

Before proceeding to Step 2, duplicate your Estimate.

Step 2: Create a Deposit-Deferred Revenue Invoice

Once the estimate is approved, the next step is to create an invoice for the customer, with a specific focus on the (service item) that contributes to deferred revenue. This invoice, reflecting a partial or whole amount of the estimate, serves as a placeholder for unearned deferred revenue and will be sent to your customer for payment.

This step is crucial, as it establishes a clear link between the estimated revenue and the actual total funds received as a deposit.

Upon receiving payment for this invoice (to undeposited funds), the corresponding bank deposit transaction should be accurately matched to ensure proper accounting and reconciliation.

Step 3: Create the Product or Service Sales Invoice

The next pivotal step is to generate the sales invoice from the estimate. This invoice, dated to the project's completion, deferral end date or service date, reflects the sale of the products or service items delivered and marks the transition from unearned revenue (Balance Sheet Liability) to earned revenue (Income Statement). Importantly, it includes a deduction for the previously recorded Deferred Revenue Deposit Invoice(s) you have collected. 

This net-zero transaction effectively moves the Deferred Revenue from the balance sheet to the income statement, signaling the transition of unearned revenue to earned revenue. This step is duplicated and distributed over the term of the deferral from the amount of the deferred revenue deposit, providing insight into future earned revenue on the Income Statement and future deferred revenue balances on the Balance Sheet. This process is particularly beneficial for businesses offering subscription-based services to gauge their expected earned revenue, follows GAAP matching and is consistent with formal financial accounting.  It is important to link the transactions using estimates and invoices, or bills and expenses rather than Journal Entries.

Note: It is possible to incorporate an accounts receivable schedule if the customer will be making date specific progress payments, that will also be deferred revenue. In this case, invoice against the a Deferred Revenue estimate, as a % of amount to be received from the customer, and defer invoices to intended collection dates, establishing the A/R schedule to the retainer-deposit date requirements.

You can also utilized standard project progress invoicing against the approved estimate based on the AIA model of % of project complete. In this case, only the amounts held as retainage typically 5%-10% (deferred revenue) + invoice(s) paid (earned revenue) would be recognized on the financial statements. The balance of the estimate remains (non posting) WIP Reports in QuickBooks Online Advanced serve as your guide to job progression. Otherwise incorporate an A/R schedule, from the estimate, based on projected construction milestones as described below.

Customization of the revenue recognition process depends on the operating standards and procedures of the business. Careful planning is required to correctly determine the products and services delivered and their respective income and expense mapping, along with the timing of deferral of revenue and prepaid bills or expenses.

Item Mapping:

if you have multiple sales channels, multiple job phases, or multiple service segments, map each item to the respective (class) income and expense on the profit and loss. This ensures your Income Statement is not complicated by multiple categories for each segment.

• Sort the sales by 'class' setup from Accounts Settings, by line or transaction.

• Add custom fields to your forms from Gear Icon > Custom Fields to further specify meaningful information on the document such as Project Mgr, Sales Rep, et...

• Location is utilized for NEXUS ship from (origin) information (business address, seller office, warehouse, inventory location, employee location, fair or tradeshow, dropshipper, et..)

• Chart of Accounts setup should follow business type

• Refunds, Discounts, Shipping, Fees and Sales Tax require special consideration depending on how the sales is processed, and if the item is taxable. You will set up sales tax in the Products and Services for taxable items individually. (default tax to location (origin) or search for specific item (destination).

GAAP Transactions (Income = COGS or Billable Expense matching)

*A sales price and/or purchase price is required for your products and services for income statement calculations.

If the items on the estimate are for:

COS Purchases (Non Inventory), These items would be mapped to (Income account=Billable Income for Invoices, Expense account=COS Billable Purchases Bills/Expenses)

If the items on the estimate are:

Inventory Items (Inventory) (Income=Sales for Invoices, Expense=COGS for Bills/Expenses)

If the items on the estimate are:

COS (Service) Item (Income account=Billable Service Income for Invoices, Expense account=COS Billable Service Expense for Bills/Expenses or Only Expense = Shipping, Fees, et....)

If the items on the estimate are:

Service Vendor Items (Service) (Income=Billable Labor income, Expense=Billable Labor expense COS Labor) (use for subcontractors)

If the items on the estimate are:

Time Item Setup (Service) (Income=Billable Time Income, Expense=Billable Time COS Labor) *turn on in Accounts and Settings > Time (use for employees) employees can easily track time against customers, jobs, service items, and whether a job is billable for improved accuracy in invoicing and job costing with QuickBooks Time Elite

Read More quickbooks.intuit.com/app/apps/home

If the items on the estimate are:

Bundle Item (Multi-Inventory) (Income=Sales for Invoices, Expense=COGS for Bills/Expenses add cost and sales price for each inventory item) *Estimated sales prices must match bundle prices for client specific estimated/invoicing. Bundles can be used for estimating common projects (eg: kitchens, bathrooms, et...) When creating Bundles, track inventory movement (eg: manufacturing) use Finished Price.

If the expense items are prepaid the following applies:

Pre-paid Expenses (any billable product or service):   Prepaids are normally expenses carrying over for 12 months. However, if the business is prepaying expenses on behalf a customer several months in advance set up the Prepaid Other Current Asset account. This process will follow GAAP matching principles

(1)  Create a Bill to the vendor being paid, categorized to the Prepaid Expense Current Asset (increase Prepaid) and pay the Bill (match in bank feed). Enter Client/Customer name in the specified field and make a note of the expense item in the description line, but do NOT mark as billable)

(2) Immediately after payment is made, create an opposing Bill dated to the revenue deferral date (GAAP: revenue = COGS expense) with the actual expense Item, previously prepaid, and mark as billable LESS (-) Prepaid Expense Current Asset (decrease Prepaid NOT marked billable.)

This net zero transaction does not affect A/P since the Bill has been paid. It reduces the Prepaid Expense Current Asset on the revenue deferral date and marks the expense to be billed creating a GAAP compliant transaction.

If the expenses are billable the following applies:

Billable Expenses (Any billable product or service): If you are using markup and have turned on markup in Accounts and Settings there are two ways to proceed:

(1) items can be marked as billable on the Estimate, and markup calculated. If Invoicing directly from the the estimate, with already marked up items, when the bills arrive, in the banking center, the field for the client is entered on a bill or expense but they are NOT marked billable. When earned revenue is realized directly from the estimate/invoice, the markup is already calculated and the difference on the Income Statement is the estimated Income less the bill fielded for the client = Gross Profit/Net Income.

(2) If the items are marked up directly from the actual expense or bill through the bank feed, and subsequently invoiced, markup will appear as a separate Income line item on the Income Statement. Billable Income and Billable Expense line items should match EOM. (typically Cost Plus Billing)

Do not duplicate items from the original estimate, that have already been converted to an invoice. Billing from the actual bills and expenses are reserved for Un-Invoiced Charges or Change Orders.

(****Caution should be taken! Failure to mark an expense transaction billable or duplications can be challenging to reconcile EOM****)

Conclusion:

Effectively deferring revenue is a nuanced process that requires careful attention to detail and adherence to accrual accounting principles. By following the outlined steps—creating estimates, converting to deposit-retainer invoices, and finalizing with sales invoices—businesses can accurately reflect their financial performance over time. This not only ensures compliance with accounting standards but also provides a clearer picture of a company's true economic standing. Whether you're in a service-oriented industry or managing subscription-based services, mastering the art of revenue deferral is key to financial transparency and sustainable business practices. See below for a brief outline of deferrals related to the type of items being deferred. I will be adding more, bookmark this page.

See also: Navigating Revenue Recognition: A Brief Guide to ASC 606 Compliance

See also: Understanding ASC 606 Revenue Recognition: Five Essential Steps

QuickBooks Online provides the software. I provide expert guidance and support. Contact me or Schedule a 30 minute free consultation

TIME AND MATERIALS DEFERRALS (Milestone Billing)

(TIP: don't use % , use whole numbers (of items) for invoices, bills and other transactions)

Products and Services Item Setup:

1. Deferral Revenue Item (deposit/retainer) (income=deferred revenue, expenses=deferred revenue)

2. COS Purchases Item (Non-Inventory) (income account=sales income for Invoices, expense account=COS Purchases Bills/Expenses)

3. Inventory Item (inventory asset, income=sales of product, expense=COGS)

4. Service Vendor Items (income=billable labor income, expense=billable labor expense COS Labor) (use for subcontractors)

5. Time Item Setup (income=billable time, expense=billable time COS Labor) *turn on in Accounts and Settings > Time (use for employees)

Enter baseline, actual or common sales prices and purchase price (markup/margin) for each item. No COGS will calculate to the income statement without this information.

Spreadsheet sync can help with the management of large products and services lists. Caution should be taken not to overwrite inventory quantities if only purchase price and sales price are to be updated. The most recent (or relevant to the Estimate and Job Phase) Bill or Invoice for a particular product is the correct COGS calculation.

Deferral Process

1.) Job Cost Project Estimate Enter the full bid details of inventory-materials quantity and amount + any other job related direct billable expenses + estimated employee time and tax + vendor time + sales tax, to send to customer for approval. Be as specific as you can, breaking down the components of the estimate into Job Phases. If you change "your cost" information on the estimate, you need to also change in Products and Services. Make a duplicate copy of this Estimate before proceeding. *check with local jurisdictions regarding state and local sales tax laws, add to products and services accordingly.

2.) Enter a Deferral Retainer-Deposit Invoice, on the date the contract is acknowledged create an Invoice for the Deferred Retainer-Deposit Item. Usually 5-10% of the estimate. Create the invoice from the estimate as a whole or % (rounded to a whole number or items), remove all lines you are NOT deferring, make an identical subtraction to those that you are, and insert the line item Deferred Revenue. Date this Deferred Revenue/Retainer Deposit unearned revenue invoice to the Current date and email to the client for payment. This is a Good Faith deposit from the client.

Immediately following; create a copy of the invoice, for the same items you just invoiced, LESS (-) the Deferred Revenue Item. Date this earned revenue invoice to Job Phase or Job Completion date to defer the sale and associated sales tax, or punch list items, final fees, or whatever you are deferring to completion. Example below.

Date specific Invoice transactions (ASC 606 Revenue Recognition)

Retainer-Deposit-current date-payment required

Deferral-date revenue will be earned on the Income Statement

Proceed only after payment has been received (to undeposited funds) and matched to the customer invoice for the job phase retainer-deposit in the banking center.

Interim Activities:

• Collect new vendor contact information, W9, or (TIN)SS#, I9, Tax Exempt Certificates, General Liability Certificate of Insurance and full contact information, including email address, ACH information, direct deposit. **Workforce (self-service)

• HR communications/Payroll setup **Workforce (self-service)

• Building Permits

• Pre Inspections

• Insurance

• Sales Tax Permits

• Construction Bonds

3.) Create an Invoice from the Job Cost Project Estimate custom amount for each line, for each Job Phase expected beginning date (typically each Job Phase will reduce the balance of the construction loan or total estimate proportionally, whichever is applicable) This will increase Accounts Receivable and break out the needed inventory items by Job Phase for Purchase Order Management.

**Note: these invoices will not calculate Cost of Goods Sold correctly on the Income Statement without a bill (paid or unpaid) for inventory- materials or inventory-materials already in stock, and at least a standard sales and purchase price for each inventory product or service. Cost of Goods sold is calculated from the Products and Services List. Be sure it is updated and current (preliminary physical inventory count should be conducted). The bill associated with the Invoice is the correct COGS calculation (use identical bill and invoice numbering to connect). Attention to date, customer, and job detail is required for accurate accounting.

4.) Once all Job Phase invoices are entered to A/R, begin to enter Purchase Orders from the Job Cost Project Estimate Duplicate (leave in pending status).

• Run an Inventory Valuation Detail Report (showing FIFO) and/or an Open Purchase Order report to determine the status of inventory requirements, by date, customer and Job Phase. The A/R Invoices to the client, will show up on the Inventory Valuation report as a negative quantity and negative value (if not already in stock), until items are on a PO and the Bill received adding to inventory, to balance the sale invoice already recorded.

• Email PO's to vendor(s) line by line for each relevant vendor, and relevant Job Phase, with terms of required delivery date, consistent with the relevant Job Phase beginning date (or a few days in advance) for Purchase Order Management and Reporting

• A PO sent to a Service Vendor will notify them of contract acceptance. Insert a description of expected job phase service dates, for scheduling purposes and, if necessary send a purchase order to HR to begin an employee hiring/scheduling process.

• Give each vendor permission to the custom forwarding email, where they will send bills, and also collect their ACH payment info for bill payments 

• Then wait for Vendor(s) ...….Enter a Bill against a PO only after Delivery of Inventory has been confirmed (Bill/Inventory Approval) or for Service Vendors, date the Bill to intended work performed schedule (Bill/Service Approval)

Interim Activities:

• Pay Vendor(s) if inventory has been received, or service is performed, follow up on backorders.

• Pay Sales Tax Collected

• Payroll and Taxes

• Inspections

• PO Reviews, Inventory Status Reviews, WIP Reviews, Payroll and Subcontractor Reviews and Estimate vs Actuals Reviews (Change Orders)

As the jobs progresses monitor job progress for change orders. Any cost over and above the original estimate is a Change Order, as determined by the Estimate vs Actuals Reports. Change Orders should have the clients signature and are entered as separate invoices to a Billable Expense Check in with the status of Estimate vs Actuals Reports often to avoid major overages. Also capped time spending for employees and subcontract vendors, determined by the original estimate. Any overtime would also be considered a Change Order and invoiced accordingly.

5.) Limbo Alerts: Automation (Project Management): Deferring the A/R Job Phase Invoices you entered, over and above the 1st deferred deposit retainer, require special workflow adaptations. (Step 2: of the Deferral Invoice Process (1) Beginning date of the next Job Phase (2) Ending date of next Job Phase) These are the dates you would expect to:

(1) Invoice for the next Job Phase Deferred Retainer-Deposit and

(2) Recognize Revenue for the Job Phase completion.

Proceeding to the next Job Phase would be stalled if the preceding Job Phase work is incomplete, the new Job Phase deferred invoice is not paid or the building departments inspection approval is outstanding. Include inspection requests in your workflows in advance of the job phase deferral date (end date), if applicable.

For these limbo transactions, use workflow alerts to be notified of the time to completely actualize the limbo deferral transactions since, from the beginning (contract acknowledgement), goods and services were not yet delivered, and the contract for the revenue, is unearned and not collected for the secondary A/R invoices. Their purpose was for Job Phase PO Management. These secondary A/R transactions are really neither A/R nor Deferred Revenue. Deferring these secondary A/R (Job Phase Invoices) is beneficial to cash flow projections (future dated P&L) and project management and is more closely associated with ASC 606

*Consult with a CPA to determine if these Job Phase invoices should remain A/R or be Deferred.

Understanding the difference between A/R and Deferred Revenue

Accounts receivable (AR) refers to the money that a company is entitled to receive from its customers for goods or services that have been delivered but not yet paid for.

Category: It is an asset on the company's balance sheet, representing the amount of money that is expected to be received within a short period (usually 30 to 90 days) from the date of the sale or service.

Deferred revenue, also known as (revenue recognition) unearned revenue or deferred income, represents money that a company has received in advance for goods or services that it has not yet delivered.

Category: It is a liability on the company's balance sheet until the goods or services are provided. Once the products or services are delivered, the revenue is recognized to the income statement, and the liability is reduced.

See also: Providing a clear picture of the Profitability of Manufacturing Assemblies and Construction

Demystifying Revenue Deferral: A Step-by-Step Guide