Legal Definitions - deferred credit

A deferred credit is an accounting term for money or value that a company has received upfront for goods or services that it has not yet delivered or performed. Instead of immediately counting this money as earned revenue, the company records it as a liability on its balance sheet. This is because the company still owes the customer the promised goods or services. The revenue is then recognized gradually over future accounting periods as the company fulfills its obligation.

• Example 1: Annual Software Subscription

  Imagine a software company that sells an annual subscription for its product for $120. A customer pays the full $120 upfront on January 1st. The software company receives the cash immediately, but it has only provided one month of service. It cannot recognize the entire $120 as revenue in January. Instead, it records the $120 as a deferred credit (a liability) on its books. Each month, as the company provides the service, it will recognize $10 ($120 divided by 12 months) as revenue and reduce the deferred credit by the same amount. By December 31st, the entire $120 will have been recognized as revenue, reflecting the full delivery of the service.

• Example 2: Unredeemed Gift Cards

  Consider a retail store that sells $500 worth of gift cards during the holiday season. When the store sells these gift cards, it receives cash but has not yet provided any goods or services. The store now has an obligation to provide merchandise when the gift cards are eventually redeemed. Therefore, the $500 is recorded as a deferred credit (a liability). Only when a customer uses a gift card to purchase items does the store recognize that portion of the $500 as revenue, simultaneously reducing the deferred credit amount.

• Example 3: Prepaid Rent for a Landlord

  Suppose a landlord rents out an office space and receives three months' rent in advance from a new tenant, totaling $9,000. The landlord receives the full $9,000 upfront. However, at the time of receipt, only one month's worth of occupancy has been provided. The remaining $6,000 for the next two months represents an obligation to provide future occupancy. The landlord initially records the $9,000 as a deferred credit. As each month passes, $3,000 is recognized as rental revenue, and the deferred credit is reduced by that amount, reflecting the fulfillment of the landlord's obligation to provide the space.