Deferred revenues refer to:
A. Cash received from customers in advance of the good or service to be provided.
B. Revenue being recorded prior to cash collection from the customer.
C. Revenue being recorded at the same time the cash is collected from the customer.
D. Cash being collected from the customer after the revenue is earned.
The Correct Answer and Explanation is :
The correct answer is A. Cash received from customers in advance of the good or service to be provided.
Explanation:
Deferred revenues (also called unearned revenues) refer to the situation where a company receives cash from a customer before it has provided the goods or services that the customer has paid for. This is common in industries such as subscription services, insurance, and prepaid memberships.
When a business collects money in advance, it has an obligation to fulfill the service or deliver the product in the future. According to the accrual basis of accounting, revenue cannot be recognized until it is earned, which in this case happens when the goods or services are provided to the customer. Therefore, the company records the cash received as a liability, rather than revenue, on its balance sheet until the product or service is delivered.
For example, consider a company that sells a one-year magazine subscription. The customer pays for the subscription upfront, but the company will recognize the revenue over the course of the year as the magazines are delivered. At the time of the payment, the company will record a liability (deferred revenue) and recognize the revenue each month as it provides the magazines.
Deferred revenue helps align revenue recognition with the actual delivery of the product or service, which is consistent with the revenue recognition principle in accounting. This principle ensures that financial statements accurately reflect the company’s performance by recognizing revenue only when it is earned.
If the business fails to deliver the goods or services, it still owes the customer the service or a refund, so the liability remains on the books. Once the service or product is provided, the liability is reduced, and the revenue is recognized in the income statement.