Understanding Deferred Revenue and its Implications on Financial

Monies received but not yet earned are considered Deferred Revenue. Under accrual accounting, deferred revenues are liabilities on the balance sheet. Liabilities are considered financial obligations of the company. If, for example, the company were to go bankrupt or otherwise found themselves unable to deliver the promised goods, they may be responsible for paying back people who have paid for services that will not be rendered. (https://www.investopedia.com/ask/answers/032615/why-deferred-revenue-listed-liability-balance-sheet.asp [>) Revenue is only recognized after the goods or services have been delivered to the customer or at a predetermined time such as per month at the beginning of the month. Because of the fact that cancellations are not uncommon, the proposal is not ethical. By recognizing revenue that is unearned, they are artificially inflating their gross receipts. This makes the business look stronger than it actually is. This also eliminates the liability on the balance sheet. If the company were unable to provide the services or the customer cancels the contract (which was stated as not being uncommon), then there is no place where those prepaid services are accounted for. Both the P&L and balance sheet would be misrepresented, and the GAAP principal of revenue recognition is no longer being followed. Revenue would be recognized before corresponding expenses which would show a higher profit margin immediately but a declining one as the expenses corresponding to the previously recognized revenue hit the books. All parties involved would be affected. Customers who do not receive services as promised have no guarantee that they would receive any of their money back. Anyone receiving dividends would be overpaid because revenue would be overstated. Retained earnings would also be way overstated as well. And if there ended up being a large number of customers who cancelled with no new memberships to offest the cancellations, then the business has the potential to go in the red. They may benefit from it in the short run, but in the long run, they stand to lose a lot.