What is Deferred Revenue, and How Does it Work for SaaS Businesses? 

ASC 606 standard mandates suggests that a business shouldn't recognize revenue until services have been delivered. 

But what does this mean for your SaaS, where getting paid upfront for subscriptions is a standard practice? 

How do you recognize revenue from services sold but yet to be delivered? 

This is where deferred revenue comes in – a critical metric that shapes how subscription businesses recognize and report their income.

Whether you're growing your SaaS or in charge of the finances of a legacy software business, understanding deferred revenue is critical.

In this guide, we'll break down everything you need to know about managing deferred revenue in SaaS — including examples, how to track, and using technology to automate the entire process.

What is deferred revenue?

Deferred revenue refers to payments received from customers for services or products that have yet to be delivered.

In SaaS, customers often pay upfront for subscriptions—monthly, quarterly, or annually.

But, according to GAAP (Generally Accepted Accounting Principles), revenue can only be recognized when the service is delivered, not when payment is received. This is the primary principle of accrual accounting.

This means a fraction of total revenue is recognized incrementally for a one-year prepaid subscription as the service is delivered monthly. The remaining portion, which hasn’t yet been earned, is recorded as deferred revenue on the balance sheet.

Are deferred revenue and unearned revenue the same? 

Yes!  Deferred revenue and unearned revenue are the same. It represents the opposite of unbilled revenue (or accrued revenue), which is revenue earned but not yet invoiced.

Why does deferred revenue matter so much in SaaS?

Deferred revenue gives an accurate insight into the future performance of your SaaS business. 

During the month-end close process, if you see deferred revenue growing consistently for upcoming months, It's a good indication that your business is likely preparing for a growth spurt.

In contrast, if you notice a decline in deferred revenue, it means subscriptions are not getting renewed, AKA a decline of business. Keeping track of these numbers allows you to understand 

potential customer churn and adjust your business strategy.

It also:

• Gives a clear view of your company's financial obligations and offers a more accurate representation of its fiscal health.
• Demonstrate your company's ability to secure long-term business from customers, building investors' trust.
• Allows effective management of liabilities by tracking the company's obligation to deliver services in the future, ensuring that the business does not overcommit or overspend.
• Improves your understanding of business net income.
• Helps understand the negotiating power in the relationship between the seller and the customer.
• Surfaces insights on how to change pricing models to improve cash flow for the business.

How do you calculate deferred revenue? 

You can calculate deferred revenue for SaaS accounting by subtracting total recognized revenue from the total value of invoices.

‍Deferred Revenue = Total Invoices Value  - Total Recognized Revenue

‍In practice, this means tracking what you've billed versus earned through service delivery. Let's look at a few real examples. 

Examples of deferred revenue in SaaS Businesses

Example 1: Simple Prepaid Subscriptions

Imagine you sell an annual data platform subscription for $36,000, paid upfront on March 1st.

On day one, the entire $36,000 sits as deferred revenue.As you provide service each month, you recognize $36,000/12 = $3,000 as revenue. By March 31st, your deferred revenue balance drops to $33,000, and $3,000 moves to recognized revenue.

This continues monthly for the entire contract term until you've delivered all services and recognized the full amount.

For example, you would have recognized $36,000 as revenue at the end of the contract term, and deferred revenue would be $0. 

However, for complex SaaS businesses with multiple subscription tiers, varying contract start dates, and different billing cycles, tracking deferred revenue can get complicated quickly.

Example 2: Prepaid Subscription with Implementation Fee

Let's look at a more complex scenario where a customer purchases your platform for $30,000 annually plus a one-time $6,000 implementation fee. 

On day one, you receive $36,000, but how you recognize this revenue differs. 

You can choose to recognize the implementation fee immediately as it's a distinct service delivered upfront. 

The remaining $30,000 becomes deferred revenue, recognized at $2,500 monthly. By month end, your deferred revenue balance is $27,500 ($30,000 - $2,500), with $8,500 recognized ($6,000 implementation + $2,500 first month).

Or you can choose to recognize the implementation fee evenly over the contract term.In that case, the entire $36,000 becomes deferred revenue, recognized at $3,000 monthly (Subscription fee $2,500 + Implementation fee $500)

This gives you a smoother, more predictable revenue recognition pattern throughout the year.

Example 3: Deferred Revenue forUsage-based Subscription

Imagine a customer signing up for your API service with a $24,000 base subscription and $12,000 in usage credits, paying $36,000 upfront. The usage is billed at $100 per 1,000 API calls.On day one, the entire $36,000 sits in deferred revenue. However, you'll recognize revenue in two ways:

• The base subscription ($24,000) is recognized evenly at $2,000 per month
• Usage credits ($12,000) are recognized at $100 per 1,000 API calls consumed

For example, in January, the customer makes 8,000 API calls, using $800 worth of credits (8,000 calls × $100/1,000 calls). Your deferred revenue balance becomes $33,200 ($36,000 - $2,000 base - $800 usage). 

By the end of the year, they'd used 120,000 API calls, consuming all $12,000 in usage credits, and received 12 months of base subscription service, bringing the deferred revenue balance to zero.

How to record deferred revenue on the balance sheet

In accrual accounting, payments and expenses are typically recorded as credit, while income earned is debit.

However, deferred revenue is recorded as a liability (credit) on the balance sheet. Because even though the money is in your bank, it hasn't been earned yet. It represents the company's obligation to deliver goods or services in the future.

As services are delivered, the deferred revenue liability is reduced (debited), and revenue is recognized (credited) on the income statement.

Journal entry for deferred revenue

When a customer makes an upfront payment, two accounting entries are created simultaneously:

1. Debit: Increase in current assets (Accounts Receivable from upfront payment)
2. Credit: Increase in current liabilities (Deferred Revenue for 12 months of service)

For example, if a customer pays $12,000 for your annual analytics subscription. Here's how the journal entry looks in your books on Jan 1:

Each month, as you deliver service, the liability decreases. This is recorded as a debit to the deferred revenue account, and as you deliver service, you start recognizing revenue. This increase is recorded as a credit to the revenue account.For example, at the end of January 31, a new journal entry will be created with the following entries:

These monthly entries will continue until you've delivered all services and your deferred revenue reaches zero.

Deferred vs. recognized revenue: What’s the difference?

Deferred vs. recognized revenue are both critical components in accrual accounting. According to the ASC 606 revenue recognition standard, it determines when you can count payments as actual revenue.

Here's how they differ:

How does Zenskar automate deferred revenue?

Zenskar's approach to deferred revenue is unique. Instead of closely tying billing with revenue recognition, Zenskar completely decouples them while keeping contracts as the source of truth.

When a contract is configured, Zenskar defines AR (accounts receivable) rules that dictate billing logic—such as invoicing frequency and amount—separately creates revenue recognition rules, determining how revenue is recognized over time (e.g., straight-line or usage-based).

For example, a six-month prepaid subscription of $6,000 is governed by an AR rule that specifies an invoice of $6,000 upfront. Simultaneously, a performance obligation (POB) dictates how revenue is recognized—whether evenly over six months, based on usage, or any other ways.

Unlike traditional processes, where accountants manually create journal entries for each AR transaction to move deferred revenue to recognized revenue (shifting amounts from liability to income), Zenskar automatically manages the relationship between billing and revenue recognition timing. It intelligently determines whether revenue is ahead of billing (creating unearned revenue) or billing is ahead of revenue (creating deferred revenue) at any given moment. 

Once everything is set up, Zenskar automatically generates the appropriate journal entries (e.g., deferred revenue to recognized revenue) and syncs them directly to your general ledger, helping you close books faster.

‍Book a demo with Zenskar today.

Deferred Revenue FAQs

Is deferred revenue an asset or a liability?

Deferred revenue is a liability on your balance sheet, not an asset. Even though you've received payment, you still need to deliver the service to your customer. This makes it a debt you owe in the form of future services. Once you provide these services, the amount moves from your liability column to your revenue.

What is the difference between accrued revenue and deferred revenue?

While both involve the timing of revenue recognition, these are opposite scenarios in the revenue cycle.

Deferred revenue happens when customers pay you before you deliver the service. For example, when they pay upfront for an annual subscription, you have the cash but haven't earned it yet.

‍Accrued revenue is when you've delivered the service but haven't been paid yet. You've earned the revenue, but the cash isn't in your bank. This commonly happens with usage-based pricing where you bill customers after they use your service.