deferred revenue impact on 3 statements
just want to double-check my walk-through of how an increase/decrease in deferred revenue flows through the 3 statements, and an additional question about what happens when there's expense recognition associated with the deferred revenue recognition.
$10 increase is easy:
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income statement: no impact because no revenue recognition
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cash flow statement: add $10 to cash
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balance sheet: add $10 to cash (asset), $10 to deferred revenue (liability) - balance sheet balances
$10 decrease seems a bit more tricky because of expenses and tax associated with revenue recognition:
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IS: add $10 to revenue, because revenue is recognized, suppose 40% tax rate and no expenses associated with the revenue recognition, then net income is $6
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CS: $4 cash outflow due to tax payment -- but how does it actually get recorded on CS? I should record net income +$6, but what item should I record to get a +$10 and to arrive at -$4 total cash flow? Is it "minus non-cash revenue of $10"?
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BS: $10 decrease in deferred revenue(liability), +$6 retained earnings from net income (equity) , -$4 in cash (asset) - BS balances
Question:
how does it work when I have expenses associated with the revenue recognition?
Assume $10 in deferred revenue is recognized, $2 non-cash expenses associated with it, 50% tax rate.
-IS: +$10 to revenue, -$2 in expenses --> EBT = $8--> -$4 tax --> $4 net income
-CS: +4 net income, minus non-cash revenue $10, plus non-cash expenses $2--> -$4 total cash impact, is it correct?
-BS: -$10 deferred revenue, +4 retained earnings, -$4 cash, what am I missing in order to balance the BS?
For increase pretty sure it goes on the IS
no
Your $10 increase is incorrect. A Golden Rule to remember for anything to do with taxes/cash, is that you're always taxed when CASH comes in, not when it's recognised as revenue in your accounting books. For example, if I received $10 in cash today for something I would only recognise in revenue 1 year from now, I would pay tax on this today; but because I now do not need to pay any tax when the revenue comes into my books, I can recognise this as a Deferred Tax Asset (a shield from future tax obligations). See proper adjustments below and be aware Tax Expense -> Accounting Book, Taxable Income -> Tax Book.
$ 10 Increase:
'Tax' Income Statement:
Taxable Income: (this is NOT the same as Income before Taxes): +$10
Taxes Paid: 10 * 0.4 = 40
Deferred Tax Asset: +4
Balance Sheet:
Unearned Revenue: +10
Deferred Tax Asset: +4
Cash: +6
$ 10 Decrease:
Income Statement
Revenue: -10
Tax Expense: -10*0.4 = -4
Net Income: -6
Balance Sheet
Unearned Revenue: +10
Deferred Tax Asset: +4 (or DTL -4, no difference)
Retained Earnings: -6
With Expenses, it's the same procedure; suppose COGS are 3% of revenue, so:
Income Statement
Revenue: -10
COGS: -0.3
Tax Expense: -9.7*0.4 = -3.88
Net Income: -5.82
Balance Sheet
Unearned Revenue: +10
Inventory: +0.3
Deferred Tax Asset: +3.88 (or DTL -3.88, no difference)
Retained Earnings: -5.82
A $10 decrease in deferred revenue makes revenue on IS go down? lol
If you can re-read my reply and point out where exactly I made such a claim, that would be great. The first example is about an increase in deferred revenue through getting paid in cash, the second is about a decrease in revenue (from aggressive revenue recognition) and how that impacts the statements. A decrease in deferred revenue would just be an increase in revenue and that's it.
I don't think companies pay taxes when they receive cash payments, unless they use the cash accounting method. But, any large company would use GAAP accrual accounting, and under that, you don't pay taxes until revenue is recognized.
an excerpt from robinhood on this -
The Internal Revenue Service (IRS) allows business owners to use the cash accounting or accrual accounting method to calculate their taxable income.
If a company uses the cash accounting method, then deferred revenue is irrelevant — the company pays income taxes as it receives payments no matter what. However, companies that use the accrual accounting method – required by the generally accepted accounting principles (GAAP) that most large corporations use – are able to defer income taxes to a later date once they’ve actually “earned” the revenue by making good on their promises, as we’ve discussed.
Also, for anyone interested, I did some research and think the below is correct when accounting for decrease in deferred revenue:
Assume $10 in deferred revenue is recognized, $2 cash expenses associated with it, 50% tax rate.
-IS: +$10 to revenue, -$2 in expenses --> EBT = $8--> -$4 tax --> $4 net income
-CS: +4 net income, minus non-cash revenue $10 --> -$6 total cash impact
-BS: -$10 deferred revenue, +4 retained earnings, -$6 cash (paying expenses and tax)
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