Accounting for Subscriptions Revenue
Subscriptions revenue is the business model that company charges the recurring fee base on a monthly, quarterly, or annual basis. It is the revenue that company receives by continue offering the monthly service to the customers. The customers must keep paying to consume the service. Subscriptions mostly use in our daily life such as Netflix, Amazon Prime, and many others.
The business will require the customers to pay upfront before consuming the service. Some companies even encourage the customesr to pay a year in advance in exchange for a huge discount.
The company will receive payments and provide service base on the package period. They have record unearned revenue and reclass to revenue during the subscription period.
Subscriptions Revenue Journal Entry
The company only records revenue after goods or service delivery to the customers. In the subscription model, the company will receive the money first and provide service later. The service is base on the contractual period, so the revenue must be allocated base on the period as well. We cannot recognize the revenue base on cash received.
The revenue should be recognized on a monthly basis which enables the management to compare the company performance from one month to another. It is also basic for the company to prepare quarterly and annual financial statements. When we already make a proper revenue allocation every month, it will help to ensure the accuracy of our financial statements at the year-end.
- Initial Journal Entry
When the customers make payment, the company should make journal entry by debiting cash and crediting unearned revenue (differed revenue). Unearned revenue is the liability that is present in balance sheet, so the transaction is not impacted the income statement yet.
- Month-End Journal Entry
At the end of each month, the company needs to make a journal entry to reclass unearned revenue to revenue. It will ensure that our recording reflects with matching principle, revenue is recorded when service is provided to customers. The amount record here equal to cash receive divided by the number of month that service cover. The number of months must include any promotional period.
The company will record revenue at the end of the month until the unearned revenue decrease to zero at the end of the contractual period.
Subscription Revenue Example
Company ABC is an internet service provider in a samall city. In order to increase sale, the company offers 2 months free service for customer who purchases 1-year plan which cost $ 1,200. On 01 April 202X, Mr. A purchase one year plan, $ 1,200, and receive two months of free service.
Please prepare a journal entry for company ABC.
It is a subscription service that customer agree to pay $ 1,200 in exchange for internet service for 14 months (1 year plus 2 months free). So the company needs to allocate the total revenue to each month.
- On 01 April 202X, The company need to make journal entry by debiting cash $ 1,200 and unearned revenue $ 1,200 as they are not yet provide any service to customers.
- On 30 April 202X, the company needs to recognize the revenue at the end of each month when service is delivered to the customers. They need to calculate revenue per month by divide total amount by the number of months. Revenue per month is $ 85.71 ($1,200 / 14 months)
The company needs to record this transaction from the 1st month to 14th month. At the end of 14th month, unearned revenue will decrease to zero and the total revenue record will equal $ 1,200. We can refer to the following table to reflect revenue recognition and unearned revenue.
- Recurring Revenue: company can generate a long-term relationship with the customers and generate recurring revenue over time.
- Increase sales: company can low down the price per month which allows them to increase the sale to customers.
- Flexible: Customers can stop the subscription at any time. They will stop the purchase when the service quality decrease.
- Maintain quality: The company needs to maintain good quality for the customers in order to keep them subscribed.
- High competition: The competitors can join the market and offer similar services at lower prices. The customers will turn to the competitors as there is no barrier to them.