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Hi everyone, welcome back to frappe school. This is the sixth chapter in our advanced accounting course. Today we will be discussing deferred revenue and deferred expenses. By the end of this chapter, you will learn about deferred revenues, about deferred expenses, how sales and purchase cycles work for deferred revenues and expenses, and the various reports you can explore linked to these transactions. Let's first understand what deferred revenue is.
Deferred revenue refers to advanced payments that an organization receives for products or services to be delivered or carried out in the future. It is also known as unearned revenue. For example, the annual subscription amount you pay for fitness services—the organization that receives the payment for the entire year records the amount as deferred revenue on its balance sheet as a liability. Deferred revenue is a liability because it refers to revenue that has not been earned and represents services that are owed to a customer. As the product or service is delivered over time, it is recognized as revenue on the income statement.
Now let's talk about deferred expenses. Deferred expenses are costs that have already been incurred but not yet consumed. Let's take an example of a cloud storage subscription which an organization takes. The subscription fee is recorded as an asset until such time as the services are consumed; at that point, the cost is charged to the expense. A deferred expense is initially recorded as an asset so that it appears on the balance sheet.
Let's now see how we can configure and record deferred revenues and expenses in ERPNext. First, let's explore the account settings that help us configure deferred revenues and expenses. These give us more control over how we manage deferred accounting. We can find account settings in the accounting module, or we can search for it in the awesome bar. We can scroll down the deferred accounting settings section. The first thing we can configure is the time period based on which we want to book deferred entries. The default option here is days. If days is selected, the deferred expense amount will be booked based on the number of days in each month; and if months is selected, then each month an equal amount of value will be booked, irrespective of the number of days. Next, the "automatically processed deferred accounting entries" checkbox can be selected or left unselected based on if we want deferred accounting entries to be posted automatically or not. If unselected, the entries will have to be processed manually. Next, the "book deferred entries via journal entry" checkbox helps us configure if we want journal entries to be used to book deferred transactions. If it is left unchecked, then defined entries are directly posted in the general ledger. If this checkbox is selected, another checkbox, "submit journal entries," is shown here. We can choose if we want the journal entries created to remain as a draft or be automatically submitted without any user intervention. If left unselected, then we will have to manually submit each journal entry. These settings are shared for deferred revenue and deferred expenses both.
Now let's set up a deferred revenue account and a deferred expense account in our chart of accounts. We can open the chart of accounts using the awesome bar. The advance income received raises liability on the company; hence, a deferred income account is created on the liability side. Similarly, the advance pay to the supplier for a service can be treated as a current asset; hence, a deferred expense account is created on the asset side. We can create a deferred expense account under assets and a deferred income account under liabilities.
Next, let's set up items in the item master. We can navigate to the item list using the awesome bar. Here we can open the item that has to be configured for deferred revenue; for example, the fitness subscription plan. Once we open the item master, we can scroll down to the deferred revenue section and select the "enable deferred revenue" checkbox. This will enable us to select a deferred revenue account and even add the number of months that the service is being provided for; for example, 12. Alternatively, we can create another item and set it up as a deferred expense item. In the same way, we can configure the deferred expense section instead. We can first enable deferred expense on this item, and then we can tag a specific expense account and mention the number of months.
Let's try creating a sales invoice for the deferred income item we created. We can navigate to the sales invoice list using the awesome bar and click on "add sales invoice" to create a new one. Once we open the new sales invoice, we can select the customer and add the subscription plan in the items table below. We can define the quantity and amount as well. If we click on the edit button, we can see that in the deferred revenue section the deferred revenue account is tagged and, based on the months we defined in the item master, a service start and end date is shown. We can then save and permanently submit this sales invoice. Next, we can click on the view button and view this transaction in the general ledger. We can see that the transaction amount has been debited from the debtors account since this is a sales transaction, whereas the deferred income account we created before has been credited with the transaction amount, which means that service worth the amount has yet to be fulfilled. With services over the decided period of 12 months, since this deferred transaction spans over 12 months, every month a new journal entry will be created by the system that will debit the deferred income account and credit the sales account with 1/12 the transaction amount.
Let's also try creating a purchase invoice for the default expense item. We can navigate to the purchase invoice list using the awesome bar and click on "add purchase invoice" to create a new one. Once we open the new purchase invoice, we can add a supplier and then add the service subscription plan item we created before. We can add a required by date and then click on the edit button. In the default expense section, we can see that the account is tagged and the service start and end date is shown as per the months we defined in the item master for this item. We can now save and permanently submit this purchase invoice. Next, we can view the general ledger and view this transaction in the general ledger. We can see that the transaction amount has been credited to the deferred expense account since this is a deferred expense. Since the subscription period spans over 12 months, journal entries will be automatically created each month with 1/12 of the transaction amount, and it will debit the deferred expense account and credit the actual expense account.
Process deferred accounting is a log that is created on the processing of every deferred revenue or expense per month. Even though we configure the account settings to create them automatically, they can be created manually as well. Automatic entry will have to be disabled for this as a prerequisite. We can create a backdated sales invoice and then use this tool so that deferred journal entries are created. To navigate to the process deferred accounting list, we can search for it in the awesome bar. Here we can see all previously created entries and create a new one by clicking on the "add process deferred accounting" button. Here we can first select the company and the type—for deferred revenue we can select income, and for deferred expense we can select expense. For this example, let's take revenue. Next, we can select the account where we want to book this and define the posting date along with the service start and end dates. Let's add all these details. Once we save these details, we can save and submit this. Once saved, let's navigate to the journal entry. Here we can see the entries that will be created for this deferred revenue. We can follow the same process for booking deferred expenses and select the type as expense while creating it.
This brings us to the end of the sixth chapter in our advanced accounting course. I hope this helped you understand what is deferred revenue and expenses and how to record them in ERPNext. You can read more about ERPNext on docs.erpnext.com. In the next chapter, we will discuss how to handle multi-currency accounting in ERPNext. Thank you.