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Is deferred revenue an actual liability? Like, what I mean is that I know it is income received in advance and we have not yet delivered the services.
But we don’t have to pay any amount to the customer or supplier right?Because lets suppose, we take an overdraft from a bank
There is interest charge on it and we haven’t paid it…so we will record that as liability since there will be cash outflowbut in Deferred revenue, there is no actual cash outflow to the other party..
so…is it really a liability?Why I ask this is because, in quick ratio, if a major portion of current liabilities is made up of deferred revenue, then quick ratio would be very low but infact, the company could still pay off its current liabilities
I have one more similar question relating to above..
In what circumstances will a current ratio below 2:1 and a quick ratio below 1:1 would be acceptable?
Just because revenue is deferred does not necessarily mean that cash has been received
Consider this:
we invoice for $10,000 of which $8,000 is deferred
Step 1, record the invoice:
Dr Receivables 10,000
Cr Revenue 2,000
Cr Deferred revenue 8,000There’s no money changed hands in this situation
Yes, it’s a liability to perform services in the future and, when we do, an appropriate part of that deferred revenue will be recognised:
Dr Deferred revenue 1,500
Cr Revenue 1,500And, possibly, still no money has changed hands
The settlement of the debt by our receivable is by:
Dr Cash 4,250
Cr Receivables 4,250So the recognition of revenue and the treatment of deferred revenue are separate and distinct from the receipt and recording of cash
OK?
NB all figures above are made up and don’t relate to any question in the OT material
You ask “In what circumstances will a current ratio below 2:1 and a quick ratio below 1:1 would be acceptable?”
When I used to run my own training firm I held very little inventory at the year end and very few debts were outstanding because al my clients were accountancy firms or companies of good repute and they all paid very promptly
Just before the year end I bought a car on credit and couldn’t pay for it until 4 months later when the money held in a bank deposit would be released
I had few current assets and a greater value of current liabilities so I had a current ratio of less than 2:1 in fact, it was less than 1:1!
The answer to your question depends upon what is ‘normal’ in that business, what is the board’s strategy, what is the nature of the business
Where you are a market trader buying fruit and vegetables from the wholesaler on 6 weeks’ credit and selling those purchases every day for cash, you have the interest free use of 6 weeks’ worth of sales revenue to spend as and where you wish
On day 43 (6 weeks and 1 day) you use the sale proceeds to pay the debt from day 1 and so on
So you have 6 weeks current liabilities, a tiny amount of inventory and receivables and you’ve spent your cash buying a new car. Your quick ratio is negative (say .7:1)
OK?
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