Today I was teaching the Accounting Comes Alive course, and a number of the people in the group were unfamiliar with the concept of deferred revenue. They also seemed unsure about why it is found in the Liabilities area of a balance sheet. Why, they reasoned, should revenue be a liability?
Perhaps the first confusing thing is that when people think about liabilities, they think only about money. A liability, however, can be an obligation to an outside entity either to pay or to perform. For example, when you borrow money from a bank, you have an obligation to pay it back. That’s a very simple kind of liability, and it involves only money.
Suppose you buy an airline ticket. You haven’t really bought anything tangible. Rather, you have bought a promise by the airline to transport you from point A to point B. In other words, the airline has an obligation to perform the service of transporting you. And if the airline is unable or unwilling, you have the right to ask for your money back. That is the essence of deferred revenue. It’s an obligation usually created when a customer pays for a product or service in advance. A prepaid card for a coffee chain is another good example. You have given the company some money, and they are now indebted to you in the form of coffee.
When it comes to a university, a good example is tuition. The tuition is paid up front. Once the money is paid, the university owes the student educational products and services. If a grant is paid before services are delivered, a university would consider the services to be a liability until the promise is fulfilled. These obligations to perform appear on the university’s balance sheet as deferred revenue.
Concepts like these are explored in the class, Accounting Comes Alive.
If you’re a Johns Hopkins University employee, you can sign up for the class by clicking here.