If you’ve looked at your Balance Sheet lately and noticed an increase in your bank account when a grant was received—only to see a similar bump in a liability account called Deferred Revenue—you might be wondering, 'Why is this listed as a liability when we just received cash?'In nonprofit accounting, especially under the accrual method, deferred revenue helps distinguish between money received and money actually earned. It reflects not just what’s in the bank but what still needs to be delivered, especially for restricted funds.
Why Deferred Revenue Exists: A Closer Look
In accrual accounting, revenue is recorded when it’s earned, not necessarily when it’s received. If a grant is restricted to a specific purpose, it’s effectively a prepayment to provide a service, not revenue you’ve fully earned. Only as you deliver the service—like offering meals to seniors—does that revenue actually become yours in an accounting sense.
With vs. Without Deferred Revenue
Imagine you receive a $200,000 grant in January, restricted to providing meals to seniors. You expect to spend $10,000 monthly on this service. Here’s what happens with and without a deferred revenue account.
The Tempting (But Misleading) Approach
You might feel inclined to record it all at once. In January, you’d show: - Revenue: $200,000 - Expenses: $10,000 (e.g., meal program expenses) - Net Income: $190,000That looks amazing—but is it accurate?
Why This Simple Approach is Problematic
If you record the entire grant as revenue upfront, you’ll create a few key issues:
Illusion of Profitability: January would have an exagerated surplus, while subsequent months would show only expenses, making those months look less financially sound than they actually are.
Misleading Liabilities: Your financials wouldn’t reflect your obligation to deliver meals in exchange for the $200,000.
Lack of Transparency: Stakeholders won’t see how much of the grant still requires service delivery.
A More Accurate Approach: Deferred RevenueInstead, using deferred revenue provides a clearer picture. You would accomplish this by using two sets of account.
First SetThe first set is used to track actual cash in and expenses. We'll call these accounts Bank Account 1 and Meal Program Expense. To keep things simple, we are going to assume all expenses are paid for as soon as they are incurred and that we can put all expenses in one account. In reality, you would probably have more than one expense account, and you may be incurring expenses on credit that you pay for later.
Second SetWe'll call the second set of accounts Deferred Revenue and Grant Revenue. Deferred Revenue tracks the amount of money you must spend on providing meals. Grant Revenue tracks how much money you have earned by providing those services.Here’s the bookkeeping entries that would happen under this approach:
Grant Received: You record the $200,000 in Bank Account 1 when you receive the money, but because it’s for future service, you also increase Deferred Revenue by $200,000. The Deferred Revenue account is a liability account, so it reflects that you owe $200,000 is meal services.
Monthly Service Provided: Each month, as you serve meals:
Decrease Deferred Revenue by $10,000, reflecting services delivered.
Increase Grant Revenue by $10,000, accurately tracking that you have earned $10,000 of the grant money by providing meal services.
Increase Meal Program Expense by $10,000, showing the cost of providing meals.
Decrease Bank Account 1 to reflect the month’s cash outflow.
Using deferred revenue gives you a more balanced monthly snapshot, showing stakeholders that while you have cash on hand, it’s meant for future services.
Why This Helps LeadershipMake Informed Decisions
You’ll know exactly how much service you still need to provide for the funds received.
You can better plan and avoid misinterpretations based on the bank balance alone.
Improve Transparency
Donors and board members gain clarity on how funds are allocated and used over time.
Staff can better understand why available cash may still have limitations tied to grant obligations.
Strengthen Grant Management
Deferred revenue helps track grant progress, making renewals easier with clear reporting.
It provides a clear picture for when new funding may be necessary to meet obligations.
Key Takeaways
Deferred revenue isn’t just an accounting construct—it’s a powerful tool for understanding your nonprofit’s actual financial position.
A full bank balance can be misleading, as it may conceal the fact that those funds are already allocated for specific services and cannot be used for other purposes.
Proper revenue recognition helps match income with services delivered, promoting accurate monthly reporting.
Clear deferred revenue records allow you to make better financial and strategic decisions.
Properly managing deferred revenue enhances financial clarity for everyone involved in your nonprofit, empowering you to make impactful, mission-driven decisions with confidence.