Understanding Earned & Deferred Revenue Calculations

This Help File Page was last Modified on 03/26/2018

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Understanding Earned & Deferred Revenue Calculations

This Help File Page was last Modified on 03/26/2018

An Overview of Earned & Deferred Revenue Calculations

Earned and Deferred Revenue Tracking is a somewhat complex accounting concept (one of many that are designed to ensure full employment for accountants and tax attorneys).

Within the context of the accounting procedures that most of us are familiar, every Sales Invoice that is issued would normally be considered "earned" when it is created (i.e., you're billing someone or some company for something they've purchased and, in most cases, have already received from your Company such as a Work Order, or a new System Installation).

However, when billing for Recurring Revenue, those Sales Invoices are almost never "earned" when they are "billed" to the Subscriber.

This is because the Sales Invoices for Recurring Services (e.g., Monitoring Fees, Service Contracts, Opening & Closing Reports) are almost always printed and mailed a month (or a least a week or so) in advance of when the period of service (for which they are being billed) actually begins.

So technically, if the Receipts for those Recurring Revenue Invoices - are posted before the entire period of service (for which they were Invoiced) has passed:

The required Recurring Services that was paid with those Receipts has not yet been provided (or not provided completely).

Therefore, from an accounting standpoint, the income which you received for those Recurring Services (or at least a portion of that income), could - and probably should - be considered unearned when you received it.

Obviously, once you have fully provided those Recurring Services, all of those Recurring Revenues associated Receipts are earned.

In summary, Revenue billed is not fully Earned until the service - for which the Subscriber was billed - has been fully provided.

Therefore, the Company's "books" should reflect in some manner, that the Revenues Received for those Services are Deferred (not recognized as Earnings), until the Period of Time your Company is required to provide those Services, has expired.

 

An example of tracking Deferred - and subsequently Earned - Revenue

A Subscriber is billed "Quarterly" on the 15th of the month preceding the beginning of their (billed for) service period.

They pay on time - remember this is only an example, so stop laughing.

Therefore, by paying on time they have actually paid "in advance" for the full service period that was billed for those services.

So, the Company has billed for, and received payment for services which the Company has not yet provided.

This means that a portion of this Revenue should - for accounting purposes - be Deferred (i.e., not recognized as a Sale) until it has actually been Earned.

 

Until the three months (the "Quarterly" service period for which they were billed for services) have passed, the money received for those services may already be (and in reality probably has been) spent - without fully providing those required (billed for) services.

In fact, you are only earning one month of their prepayment at the end of each month within the service period for which they were billed.  

So, at the end of each month, one month's worth of that prepayment Revenue is Earned, and this continues until the service period - for which the Subscriber has paid in advance - has been provided.

At that point, the "billed for" service period has been fully provided by the Company (and consumed completely by the Subscriber), so all of that prepayment Revenue has now been Earned..

Are you having fun yet?

 

Why did we put you through this exercise? (Who - except Einstein - likes this kind of "thought experiment" anyway?)

Growing companies - by the nature of that growth - enjoy increasing revenues month over month, and year over year.  

If some (and often much) of this revenue is from Recurring Services (e.g., Monitoring, Service Contracts, Opening & Closing Reports), and most - if not all of these services - are billed in advance as Recurring Revenues, then you may be able to "defer" some of this unearned income (for the portion of the service period that is not yet Earned) until the following tax year.

Generally, this is a good thing because the value of money declines over time, and in the meantime, you may actually be using, and/or earning interest on those Recurring Revenue payments.

Plus, when any Revenue is able to be Deferred into the following tax year, you don't have to pay taxes on that Revenue on the current year's tax return.

 

Important Note: This is actually legal - ask your accountant!

 

The Problem (Why doesn't every one do this?)

Earned and Deferred Revenue Tracking can be very difficult, and extremely time-consuming to calculate and record!

If you have not automated this process, it might cost you as much to accurately calculate your Earned and Deferred Revenues as your Company would save in Taxes.

 

For General Ledger System Users - When a Recurring Revenue Item is billed automatically, the question is:

When is the Recurring Revenue Earned for the First Month of the Period of Service being billed, and when is that First Month's Recurring Revenue Deferred to the next Month?

a)When the Auto Billing Sale Date entered is within the First Month of the Period of Service being billed, and the Starting Day - which is identified in the Billing Cycle record - is the First day (i.e., '1') of the Month and Year of the Period To Bill chosen in the Auto Billing dialog, the First Month is Earned and posted on the last day of that First Month using Post Deferred Revenue procedure);

b)Otherwise, that First Month's Recurring Revenue is Deferred until the next Month as described below (these are the only other possible cases):

i.The Auto Billing Sale Date entered is dated within the Month before the First Month of the Period of Service being billed (i.e., your Company Bills in Advance) and the Starting Day - which is identified in the Billing Cycle record - is the First day (i.e., '1') of the Month and Year of the Period To Bill chosen in the Auto Billing dialog, therefore the Recurring Revenue is Deferred to the next Month after Sale Date (which in this case is actually the First Month of the Period of Service being billed);

ii.The Auto Billing Sale Date entered is dated on or after the First day of the First Month of the Period of Service being billed, but the Starting Day - which is identified in the Billing Cycle record - is Not the First day (e.g., it is 2...31) of the Month and Year of the Period To Bill identified in the Auto Billing dialog, so the Recurring Revenue for this First Month of the Period of Service being billed will not be fully earned until the next Month, therefore the Earned Recurring Revenue for this First Month is Deferred to the next Month.

c)Earned Revenue is always posted to the General Ledger System  - using the Post Earned Revenue process - on the Last Day of the selected Month being posted, whether that process is run at the end of the Month and Year being posted, or in a subsequent (later) Month.

 

The Solution - Let the MKMS General Ledger System calculate the Earned & Deferred Revenue in the background as part of its automated Recurring Revenue Billing - and use the associated Post Earned Revenue process to record it, because it will do so with virtually no additional effort required on your part.

Earned & Deferred Revenues are calculated on a Monthly basis using the data in these fields:

a)Sale Date - This is identified in the Auto Billing dialog, and is assigned to each Recurring Revenue Invoice created for the selected Billing Cycle.

b)Bill in Advance - When the Sale Date identified in the Auto Billing dialog and recorded on the Invoice is dated within the month before the start of the Month and Year of the Period To Bill identified in that Auto Billing dialog.

c)Starting Day - Although the Starting Day - which is predefined in the Billing Cycle record - is used to determine when the Recurring Revenue Service Period will start, the actual Recurring Revenue calculations for Earned & Deferred Revenue are based on Completed Months of Service, rather than a specific number of days of service (way easier and far less complicated).

d)Month and Year of the Period To Bill - Therefore, from an Earned & Deferred Revenue basis, because the Starting Day (i.e., the Starting Day identified in the selected Billing Cycle record) of the Month and Year of the Period To Bill chosen in the Auto Billing dialog - which represents the Period of Service being Billed - is not always the "First of the Month" - when the Starting Day identified in the Billing Cycle of the Period of Service being Billed is after the "First of the Month," the Recurring Revenue will not be fully be earned until some date in the following month (this is because at least some days of service must be provided in that next month) - so the Earned Revenue for the First Month of the Period of Service being Billed will not be posted until that second month, the month in which it was fully provided).

 

Therefore, Earned & Deferred Revenues are calculated on a Monthly basis as follows:

1.When the Sale Date recorded on the Invoice is dated in the month before the Month and Year of the Period To Bill chosen in the Auto Billing dialog; and the Starting Day - which is identified in the Billing Cycle record - is the the First day (i.e., '1') of the Month and Year of the Period To Bill chosen in the Auto Billing dialog, then your Company is Billing in Advance, and not Deferring the first month's Revenue.  

a.Therefore, the first month of the Month and Year of the Period To Bill is "Earned" at the end of that first month (which is the end of the first Month and Year of the Period To Bill chosen in the Auto Billing dialog, and so the Recurring Revenue will be fully be earned at the end of the month after the month of the Sale Date.

 

2.When the Sale Date recorded on the Invoice is dated in the month before the Month and Year of the Period To Bill chosen in the Auto Billing dialog; but the Starting Day - which is identified in the Billing Cycle record - is Not the First day (e.g., it is 2...31)  of the Month and Year of the Period To Bill chosen in the Auto Billing dialog, then your Company is Billing in Advance, but will be Deferring the first month's Revenue.  

a.Because the first month of the Month and Year of the Period To Bill is "Earned" ends after the first Month and Year of the Period To Bill chosen in the Auto Billing dialog, it will be Earned two months after the month of the Sale Date.

 

3.When the Sale Date recorded on the Invoice is within the Month and Year of the Period To Bill chosen in the Auto Billing dialog; and the Starting Day - which is identified in the Billing Cycle record - is the First day (i.e., '1') of the Month and Year of the Period To Bill identified in the Auto Billing dialog, then your Company is not Billing in Advance, nor Deferring the first month's Revenue.  

a.Therefore, the first month of the Period Covered is "Earned" at the end of that month.

 

4.When the Sale Date recorded on the Invoice is within the Month and Year of the Period To Bill chosen in the Auto Billing dialog; but the Starting Day - which is identified in the Billing Cycle record - is Not the First day (e.g., it is 2...31) of the Month and Year of the Period To Bill identified in the Auto Billing dialog, then your Company is not Billing in Advance, but will be Deferring that first month's Revenue.  

a.Because the first month of the Month and Year of the Period To Bill is "Earned" ends after the first Month and Year of the Period To Bill chosen in the Auto Billing dialog, it will be "Earned" in the next month.

 

So as a general rule:

1.Whenever the Sale Date recorded on the Invoice is in a month before the Month and Year of the Period To Bill identified in the Auto Billing dialog your Company is Billing in Advance, so that associated Recurring Revenue will not be "Earned" for that first month of the Month and Year of the Period To Bill identified in that Auto Billing dialog until service for the first Period Covered month has been fully provided.

2.Whenever the Sale Date recorded on the Invoice is within the month of the Month and Year of the Period To Bill identified in the Auto Billing dialog, that associated Recurring Revenue:

a.Will be "Earned" in that month only when the Starting Day - which is identified in the Billing Cycle record - is day '1'; otherwise

b.When the Starting Day - which is identified in the Billing Cycle record - is not day '1' (e.g., it is 2...31), then the Recurring Revenue will not be "Earned" until the next Month, which is when the service for the first Period Covered month will have been fully provided.

 

Automating the Earned & Deferred Revenue Tracking Process

Preparing for Earned and Deferred Revenue Tracking when using the General Ledger System: (once this preparation has been completed, you must Run the Deferred Revenue Setup Wizard which will validate the start up process):

Define a Deferred Revenue General Ledger Account as a Liability Account - usually placed within a Current Liability General Ledger Group.

 

HelpFilesGeneralLedgerAccountDeferredRevenue

Maintenance - General Ledger - Account Form - Deferred Revenue Account

 

Assign that Deferred Revenue General Ledger Account (in the Unearned Revenue GL# field) to each Sale-Purchase Item that represents a Recurring Revenue type of Sale which should/might be Deferred.

 

HelpFilesSale-PurchaseItemGeneralLedgerDeferredRevenueAccount

Sale-Purchase Item Form - Unearned Revenue GL# field

 

Run the Deferred Revenue Setup Wizard

Note:  Before running the Deferred Revenue Setup Wizard, go into Company Settings and set the Bill in Advance option ("BillInAdvance") to True ("T") or False ("F") based on your Company's business model.  

Bill in Advance means your Company always chooses a Sale Date that is prior to the Period of Service for which you are Billing Recurring Revenue (i.e., Auto Billing).

Example:

a)You are Billing in Advance - You are running the Auto Billing process for a Period of Service which starts in March 2018, you would set the Sale Date to a date between 2/1/2018 and 2/28/18.

b)You don't Bill in Advance - If you are running the Auto Billing process for a Period of Service which starts in March 2018 and choose a Sale Date in March 2018, then your Company DOES NOT Bill in Advance regardless of when you run the Auto Billing process and mail the Invoices (which means your Company may create and mail these Invoices well in advance, as long as the Invoices are Dated in the Month and Year of the actual Period of Service.

 

Once you've made this choice [e.g., the Bill in Advance option ("BillInAdvance") in Company Settings has either been set to True a) or False b) as described above], and run the Deferred Revenue Setup Wizard, you must always run the Auto Billing process in the same way.

oIf not, the Earned and/or Deferred Recurring Revenue related reports will provide inaccurate Values.

oThis is because the Earned & Deferred Revenue calculations executed in the background take into account the Sale Date, the Starting Day, and the Date Range of the period of service being billed,

 

The Deferred Revenue Setup Wizard is used to properly initialize the Deferred Recurring Revenue feature within MKMS Accounts Receivable module and - if the General Ledger module is Registered - in the General Ledger System.

 

Once the Deferred Revenue Setup process has been completed:

1.Certain Company Settings options will be changed.

 

HelpFilesUserOptionsCompanyTabCompanySettingsButton

 

2.To view those changes, search for "Defer" in the Company Settings list to see the Setting Names associated with tracking Earned & Deferred Revenue.

 

HelpFilesUserOptionsCompanySettings-Deferred

 

3.The Setting Value of three Setting Names have been updated:

 

HelpFilesUserOptionsCompanySettings-SettingValue

 

If you are manually posting Earned and Deferred Revenue to an "outside" General Ledger, the Earned/Deferred Revenue Report (see illustration below) provides you with those Earned and Deferred Revenue Tracking Values.  

 

HelpFilesEarned&DeferredRevenueReportOptions

Deferred Revenue Report - Options tab

 

Otherwise, your Company will use the Post Earned Revenue procedure to post those Earned Recurring Revenues automatically.

 

Understanding the General Ledger System internal posting process when a Recurring Revenue Sale is created:

If the General Ledger System is activate (the DeferRecurringRevenue option is set to True), when a Recurring Revenue Invoice is created (i.e., it has one of the Recurring Revenue Sale-Purchase Items assigned to one or more Detail Line Items):

The Gross Total Value (Total Value = [the (Detail Line Item's Sales Value which is Quantity * Price) + (Sales Tax Rate * that Detail Line Item's Sales Value)] of each Detail Line Item is posted (added) to the General Ledger System's Accounts Receivable Account.

The Sales Value (Quantity * Price) of each of those Detail Line Items will be posted (added) to the Deferred Revenue General Ledger Account instead of the General Ledger Sales Account - that Deferred Revenue Account Balance will be increased (a Credit will be posted to the designated Deferred Revenue Liability Account) for the Value of each of those Detail Line Items.

The Sales Tax Value (Sales Tax Rate * that Detail Line Item's Sales Value) is added to the Sales Tax Payable Liability Account.

 

The Value of the Detail Line Item's internal Earned Revenue field is initially set to $0.00.

No General Ledger System transaction is generated for Earned Revenue.

The Post Deferred Revenue procedure (see the illustration below) automatically updates the Values in the Deferred Revenue General Ledger Account and associated Recurring Revenue Sale Accounts.

 

HelpFilesPostEarnedRevenueDialog

Post Earned Revenue Form

 

Periodically, a Post Earned Revenue procedure will be executed.

 

HelpFilesPostDeferredRevenueConfirmation

 

During this Post Deferred Revenue procedure:

The proportioned Earned Revenue Amount for each Detail Line Item is Posted (added) to the Detail Line Item's internal Earned Revenue field's balance.

The Invoice Header of any Invoice with a Recurring Revenue Sale (i.e., containing one or more Detail Line Item(s) assigned one of these Recurring Revenue Sale-Purchase Items) will also have the currently calculated Earned Revenue Amount Posted (added) to its internal Earned Amount field.

So, the Invoice Header will contain (internally) the updated Total of all of the Revenue that was Earned on that Invoice.

 

When Earned and Deferred Revenues are being tracked in the General Ledger System:

1.The Gross Amount (including Sales Tax, if charged) of each Recurring Revenue Sale is Debited (added) to the Accounts Receivable Asset Account (a Mandatory Account).

2.The Net Amount (not including any Sales Tax) is Credited (added) to the associated Deferred Revenue Liability Account

3.If Sales Tax was charged, the Amount of that sales tax is Credited (added) to the appropriate Sales Tax Payable Liability Account (i.e., Local, National, or both, as needed).

4.Then, once each month, the Post Earned Revenue dialog is used to calculate the Earned Recurring Revenue for a selected Accounting Period. Where for each detail line item

a.The Deferred Revenue Liability Account is Debited (reduced) by the Value of the Recurring Revenue that was Earned during the Accounting Period

b.The (Revenue) Sales Account assigned to the Recurring Revenue Item is Credited (increased) by the Value of the Recurring Revenue that was Earned during the Accounting Period

c.The Current Earnings Equity Account (a Mandatory Account) is Credited (increased) by the Value of the Recurring Revenue that was Earned during the Accounting Period

d.The Earnings Posting Expense Account (a Mandatory Account) is Debited (increased) by the Value of the Recurring Revenue that was Earned during the Accounting Period

 

When you Post Earned Revenue for a negative Recurring Revenue detail line item, it will do exactly the opposite:

a.The Deferred Revenue Liability Account is Credited (increased) by the Value of the Recurring Revenue that was Un-Earned during the Accounting Period

b.The (Revenue) Sales Account assigned to the Recurring Revenue Item is Debited (decreased) by the Value of the Recurring Revenue that was Un-Earned during the Accounting Period

c.The Current Earnings Equity Account (a Mandatory Account) is Debited (decreased) by the Value of the Recurring Revenue that was Un-Earned during the Accounting Period

d.The Earnings Posting Expense Account (a Mandatory Account) is Credited (decreased) by the Value of the Recurring Revenue that was Un-Earned during the Accounting Period

 

The Post Deferred Revenue table is maintained internally with a summary of the Earned and Deferred Revenues posted during the execution of each Post Earned Revenue procedure

Those previous Posted Earned Revenue records are listed on the Post Earned Revenue dialog

 

HelpFilesPostEarnedRevenueDialog

Post Earned Revenue Form

These Earned and Deferred Revenue transactions may be viewed in the Transaction File (see below).

 

Viewing the Deferred and Earned Revenue Financial Transactions posted to the Transaction File Form:

 

HelpFilesTransactionFilePostedEarnedRevenues

Transaction File Form - Post Deferred & earned Revenue Transactions

 

a)Deferred Revenue is identified as "DR" (Deferred Revenue for the associated Liability Account) in the Document Type column for each of the (Deferred Revenue) Debit entries shown above.

b)Earned Revenue is identified as "ER" (Earned Revenue for the associated Sales Account) in the Document Type column for each of the (Earned Revenue) Credit entries shown above

 

See the Post Earned Revenue chapter for additional information.