Definitions
Deferred Income: Deferred income is a liability that arises when a company receives payment from its customers for goods or services that it has not yet delivered. In the case of a software company, this can occur when customers prepay for software licenses or subscriptions that will be delivered or used over a period of time, such as a year.
Accrued Income: Accrued income is income that a company has earned but has not yet received in cash. In the case of a software company, this can occur when the company has completed work or provided a service but has not yet invoiced the customer or received payment.
Prepayments: Prepayments are a type of asset that arises when a company pays for goods or services in advance. In the case of a software company, this can occur when the company pays for expenses such as rent, insurance, or software licenses in advance.
Accrued Liabilities: Accrued liabilities are expenses that a company has incurred but has not yet paid or recorded in its accounts. In the case of a software company, this can occur when the company has received goods or services but has not yet paid for them.
Recurring Revenue:
Revenue that are contracted and recurring in nature. Examples include
- Contracted software SaaS revenue that is contracted 1 year or more
- Maintenance revenue on software or hardware under a contract
Non Recurring revenue:
Revenue that is not contracted and/or unpredictable in nature in terms of timing and amount
- Project based revenue e.g. Fees for work done.
- Transaction based revenue e.g. based on number of people going through a website
Adjustments in accounting systems
Deferred income:
Situation: Customer purchases a software for 12 months. Each months costs £1,000. The customer pays all 12 months upfront at a value of £12,000
What should happen:
1st Jan - Invoice the customer £12,000 with 90 day payment terms
- DR Accounts Receivable £12,000
- CR Deferred Revenue £12,000
1st Feb - One month of revenue is recognised
- DR Deferred revenue £1,000
- CR Sales £1,000
What happens in Xero:
1st Jan - Invoice the customer £12,000 with 90 day payment terms
- DR Accounts Receivable £12,000
- CR Sales £12,000
1st Feb - One month of revenue is recognised
- Nothing
Therefore one needs to create a manual journal to capture the deferred revenue and revenue recognition
1st Feb month close
- DR Sales £12,000
- CR Deferred Revenue £12,000
This allocates the sales into deferred revenue indicative of what happens in month 1. Then the following journal is
- DR Deferred Revenue £1,000
- CR Sales £1,000
Prepayments and cost of sales:
Situation: 120K paid in advance for a piece of software needed to service our customers
What should happen:
1st Jan - Receive a supplier invoice for 120K
- DR prepayments 120K
- CR accounts payable 120K
Then after every month you release the prepayments and recognise the COS
- DR Cost of sales 10K
- CR prepayments 10K
What happens in Xero:
But this is difficult for accounting systems to do, so instead accountants do the following
Same prepayments when getting invoiced
- DR prepayments 120K
- CR cost of sales 120K
But after every month you release the prepayments in release the new cost of sales
- CR prepayments 120K
- DR cost of sales 120K
- DR prepayments 110K
- CR cost of sales 110K
Net result in balance is
- CR prepayments 10K
- DR Cost of sales 10K (same as above)
Accrued income:
Situation: A customer which pays us £120K per annum, renews on 1st Jan every year. It is now 1st Feb, they have agreed to renew however we have not yet sent them an invoice.
What should happen:
- CR Sales £10K
- DR Accrued revenue £10K
What happens in xero:
- Nothing
Therefore a manual adjustment is required to capture the accrued revenue and sales
Formulas
Recurring revenue-Accrued Income
PSD = accounting period start date = A!D7
PED = accounting period end date = A!D7
CSD = Recurring revenue Contract Start Date = COLUMN G
CED = Recurring revenue Contract End Date = COLUMN H
IR = Invoice Raised = Yes or No = COLUMN N
IRD = Invoice Raised Date (not projected invoice date) = COLUMN I
IV = total Invoice Value = COLUMN C
IF (IR=NO) and (IRD < PED)
- If PED > CED, 100% of IV
- If PED ≤ CSD, zero value
- If PED ≥ CSD and PED ≤ CED
- (PED - CSD) / (CED - CSD+1) * IV
IF (IRD > PED) and ((CSD < PED