Deferred Revenue vs Accrued Expense: Meaning, Examples & Comparison
Understanding the difference between deferred revenue and accrued expense is essential in accounting. This topic is very important for school and competitive exams, as well as for anyone seeking practical business knowledge. It helps students avoid confusion in financial reporting and ensures accuracy in preparing and reading balance sheets and income statements.
| Point of Difference | Deferred Revenue | Accrued Expense |
|---|---|---|
| Definition | Advance money received for goods/services not yet delivered – a liability. | Expense incurred but not yet paid – a liability. |
| Cash Flow | Customer pays business in advance. | Business owes supplier; pays later. |
| Journal Entry on Initial Recognition | Cash/Bank A/c Dr. To Deferred Revenue A/c |
Expense A/c Dr. To Accrued Expense A/c |
| When Recognised as Income/Expense | When goods/services are delivered. | When expense is paid off. |
| Balance Sheet Impact | Current Liability | Current Liability |
| Common Examples | Prepaid subscriptions, advance rent | Unpaid utilities, outstanding salaries |
What is Deferred Revenue?
Deferred revenue is the advance payment that a business receives from a customer before delivering goods or services. It is also known as unearned revenue. Since the company still owes the product or service, this payment is shown as a liability in the balance sheet. Once the obligation is fulfilled, it becomes earned revenue and is shifted to the income statement.
Examples of Deferred Revenue
- A magazine publisher receives payment for a yearly subscription, but has yet to deliver all issues.
- A software company gets advance payment for a 12-month license, with services provided throughout the year.
What is Accrued Expense?
Accrued expense is an expense that a business has incurred but has not yet paid. It is recognized in the books of accounts before the payment is made, based on the accrual accounting principle. This makes sure that expenses are matched with the period in which they are incurred, even if the cash payment happens later. Accrued expenses appear as liabilities in the balance sheet.
Examples of Accrued Expense
- Electricity consumed in March but paid for in April is recorded as an accrued expense in March.
- Employee salaries for the last week of the month, which will be paid in the next month.
Key Differences: Deferred Revenue vs Accrued Expense
The main difference between deferred revenue and accrued expense is the direction of cash flow and the timing of recognition. Deferred revenue involves receiving cash before earning it, while accrued expense means owing money for an expense already incurred. Both are classified as current liabilities in the balance sheet, but their treatment in accounting entries is different.
Journal Entry Impact
When a company receives advance payment, it records:
- Debit: Cash/Bank
- Credit: Deferred Revenue (Liability)
When the service is delivered, the entry is reversed:
- Debit: Deferred Revenue
- Credit: Revenue (Income)
For accrued expenses, when an expense is incurred but unpaid:
- Debit: Expense Account
- Credit: Accrued Expense (Liability)
When the business pays:
- Debit: Accrued Expense
- Credit: Cash/Bank
Common Mistakes and Importance in Exams
- Students often confuse which party receives cash first.
- Deferred revenue is sometimes wrongly considered income instead of a liability.
- Many fail to match accrued expenses to the correct period.
- Mistakenly interchanging deferred revenue and accrued expense in journal entries.
Understanding these concepts is critical for correct exam answers and strong foundational knowledge for business or commerce careers.
Quick Revision Chart: Deferred Revenue vs Accrued Expense
| Deferred Revenue | Accrued Expense | |
|---|---|---|
| Status | Advance received, service not yet delivered | Service received, payment not yet made |
| Accounting Entry | Liability on Balance Sheet | Liability on Balance Sheet |
| Reversal | When service/product delivered | When payment is made |
You can explore more about liabilities and their accounting treatment in Non-Current Liabilities and get practical solutions at DK Goel Solutions Class 12 Accountancy. For related adjustment entries, see Accounting Adjustments, and for the fundamentals of recording, visit Ledger Accounts.
At Vedantu, we simplify Commerce topics like the difference between deferred revenue and accrued expense to support students in their studies and business learning. Mastering these concepts helps students succeed in school exams, competitive exams, and practical accounting tasks in daily business.
In summary, deferred revenue is cash received before providing a service, listed as a liability, while accrued expense is an amount owed for a service already consumed, also a liability. Accurate understanding ensures correct financial reporting and strong exam performance.
FAQs on Difference Between Deferred Revenue and Accrued Expense
1. What is the main difference between deferred revenue and accrued expense?
The primary difference lies in the relationship between cash flow and the economic event. Deferred revenue is cash received by a business before it provides the goods or services, creating a liability to perform. In contrast, an accrued expense is an expense the business has incurred before it has paid cash, creating a liability to pay.
2. On which financial statement do deferred revenue and accrued expenses appear, and what type of accounts are they?
Both deferred revenue and accrued expenses are classified as current liabilities on the Balance Sheet. They represent obligations the business must settle within the accounting period. Deferred revenue is a liability to provide a future service, while an accrued expense is a liability to make a future cash payment.
3. Can you give a real-world example of deferred revenue and an accrued expense?
Certainly. Here are common examples based on the NCERT syllabus for Class 11-12:
- Deferred Revenue Example: A coaching centre receives the full annual fee of ₹24,000 from a student at the beginning of the year. This entire amount is deferred revenue and is recognised as earned revenue at ₹2,000 each month as the classes are conducted.
- Accrued Expense Example: A business consumes electricity during March, but the bill arrives and is paid in April. The estimated electricity cost for March is recorded as an accrued expense at the end of March to match the expense to the period it was incurred.
4. How are the basic journal entries for deferred revenue and accrued expense recorded?
The initial journal entries under the accrual accounting system are:
- For Deferred Revenue (when cash is received):
Debit: Cash/Bank A/c
Credit: Deferred Revenue A/c (Liability) - For Accrued Expense (when expense is incurred but not paid):
Debit: [Specific] Expense A/c (e.g., Salaries Expense)
Credit: Accrued Expense A/c (Liability)
5. What happens to deferred revenue when the service is provided, or when an accrued expense is paid?
When the obligation is fulfilled, an adjusting entry is made:
- For deferred revenue, as the service is rendered, the revenue is recognised. The entry is: Debit Deferred Revenue A/c and Credit Revenue A/c. This shifts the amount from a liability on the Balance Sheet to income on the Income Statement.
- For an accrued expense, when the cash payment is made, the liability is settled. The entry is: Debit Accrued Expense A/c and Credit Cash/Bank A/c.
6. How do deferred revenue and accrued revenue differ?
They are fundamentally opposite concepts in the revenue cycle. Deferred revenue is a liability because the business has received cash but has not yet earned it. Conversely, accrued revenue is an asset (a type of receivable) because the business has earned the revenue by providing a service but has not yet received the cash payment from the customer.
7. What is the relationship between deferred revenue and prepaid expenses?
They are two sides of the same coin, representing a mirror image of a single transaction for the seller and the buyer.
- Deferred Revenue is a liability for the seller, who has received cash for a service they have yet to provide.
- Prepaid Expense is an asset for the buyer, who has paid cash for a service they have yet to receive.
For instance, an annual magazine subscription is a prepaid expense for the reader and deferred revenue for the publisher.
8. Is there a difference between an accrued expense and accounts payable?
Yes, while both are current liabilities, they are not the same. Accounts Payable specifically refers to amounts owed to suppliers or vendors for goods or services received on credit, usually backed by an invoice. Accrued Expense is a broader term for expenses that have been incurred over time but are not yet due for payment and may not have a formal invoice, such as interest on a loan, salaries earned by employees, or utility costs.
9. Why is it critical to correctly classify deferred revenue and accrued expenses in accounting?
Correct classification is essential for adhering to the accrual basis of accounting and the matching principle. Misclassifying these items severely distorts a company's financial statements by:
- Understating or overstating liabilities on the Balance Sheet.
- Incorrectly matching revenues and expenses to the wrong accounting periods on the Income Statement.
- Leading to a false calculation of net profit or loss, which can mislead investors, lenders, and management.
10. In what types of businesses are the concepts of deferred revenue and accrued expenses most important?
While important for all businesses, their significance is pronounced in specific sectors:
- Deferred Revenue is critical for subscription-based companies (e.g., software, streaming services), real estate firms (receiving advance rent), and any business taking pre-payments for long-term contracts.
- Accrued Expenses are universally important but are a major focus for large organizations with significant payroll, businesses with substantial debt (accrued interest), and manufacturing firms (accrued utilities and wages).
