Tax and accounting terms
Deferred Revenue Explained: Money Received Before It Is Earned
Liabilityis where deferred revenue sits until the goods are delivered or the service is performed, because until then the business still owes the customer.
Sources checked October 20263 min read
What deferred revenue is
Deferred revenue, also called unearned revenue, is money a business receives before it delivers the goods or performs the service it was paid for. Annual subscriptions, retainers, prepaid memberships, gift cards and customer deposits all create it. Until the business delivers, it owes the customer the goods, the service or a refund, so the amount sits on the balance sheet as a liability rather than as revenue.
As the business delivers, the liability shrinks and the revenue is recognized. A corporation reports the remaining balance on its GIFI as deferred income, code 2770, among its current liabilities.
| Step | Amount |
|---|---|
| Cash received on October 1 | $1,200 |
| Earned by December 31, 3 of 12 months | $300 |
| Deferred revenue at year end | $900 |
| Earned in the following year | $900 |
Key points
- Money received in advance is a liability until the business delivers what it was paid for
- For income tax, amounts received for goods or services not yet delivered are included in income when received
- A reasonable reserve can be deducted for what is still to be delivered after year end, and is added back the next year
- GST/HST is not charged on a deposit until it is applied to the price, or on a gift card until it is used
How advance payments are taxed
The Income Tax Act starts from a different place than the accounting. An amount received in the course of a business for services not yet rendered or goods not yet delivered is included in income in the year it is received. The business can then deduct a reasonable reserve for goods it expects to deliver, services it expects to perform, and rent paid in advance for periods after year end. The reserve deducted one year is added back to income the next, and a new reserve is claimed for whatever is still outstanding.
In the membership example, the full $1,200 is included in income in the year it is received, and a reserve of $900 for the nine months still to be provided brings the taxable amount down to $300, matching the accounting. Gift cards follow the same pattern: the sale is reported as business income on the day the card is sold, and a reserve can be deducted for cards expected to be redeemed after year end.
GST/HST on deposits, prepayments and gift cards
Sales tax timing differs again. No GST/HST is charged when a customer pays a deposit toward a taxable purchase; the tax is collected when the deposit is applied to the price. If the customer walks away and forfeits the deposit, the amount kept is subject to GST/HST, worked out as the tax fraction of it, such as 5/105 where only GST applies.
A payment of the price itself in advance is different from a deposit. GST/HST becomes payable when the payment is received or due, whichever is earlier, so a customer who pays the full price up front generally pays the tax at that point. Gift cards are the exception in the other direction: no GST/HST is collected when the card is sold, and the tax is calculated on the full price of whatever the customer buys when the card is used.
Quick answers
Is deferred revenue an asset or a liability?
A liability. The business has been paid but still owes the customer the goods, the service or a refund. It becomes revenue as the business delivers.
Is money received in advance taxable when it arrives?
For income tax it is included in income when received, but a reasonable reserve can be deducted for goods and services still to be delivered after year end, so in practice it is taxed as it is earned.
Do I charge GST when I sell a gift card?
No. GST/HST is calculated when the card is used to pay for a taxable purchase, on the full price of that purchase.
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Important. This article provides general educational information, not legal or tax advice for a specific business. Rules, administrative policies, rates and deadlines can change. Confirm your facts and current obligations with the responsible government agency and a qualified adviser.