One of the benefits is that companies can offset their current year’s tax burden.
When income is recognized, it becomes taxable. By utilizing deferred revenue, perhaps in conjunction with taking a net operating loss, taxes can be postponed to a later date while the income can be reinvested today.
Remember that strategic timing allows companies to delay their tax bill, not eliminate it.
Let’s Look at an Example
The most common reason to use deferred revenue accounting is when an organization receives money upfront for services provided over time.
For example, consider a SaaS company that sells pre-paid subscriptions. They’ll collect the money upfront but defer reporting the revenue over the contract’s lifetime. Even though they receive the money all at once, deferred revenue is the proper way to recognize the income since ongoing costs of doing business remain throughout the subscription period.
Other services that often make use of this strategy include:
- Newspaper Subscriptions: A publishing company that charges annually for a daily periodical.
- Fitness Memberships: A gym that collects upfront fees on annual memberships.
- Insurance Premiums: An insurance company that collects premiums at the beginning of a policy period but is obligated to provide insurance over time.
