Before You Start

This guide assumes familiarity with accrual basis accounting and basic journal entries. Administrator access to your accounting software (e.g., QuickBooks Online, Xero) is also required.

Overview

25 min
Setup Time
Advanced
Difficulty
Monthly
Maintenance

What You’ll Learn

  • Understanding unearned revenue under ASC 606
  • Setting up a dedicated liability account for retainers
  • Recording initial retainer payments correctly
  • Creating monthly journal entries for revenue recognition
  • Reconciling the deferred revenue liability

1. Understanding Deferred Revenue

To accurately account for service retainers, you’ll primarily need these account types:

Required Accounts

  • Unearned Revenue (Liability)
  • Service Revenue (Income)
  • Bank Account (Asset)

Optional (but recommended)

  • Client Deposits (Liability, for short-term advances)
  • Accounts Receivable (Asset, if invoicing before payment)
  • Retainer Tracking (Sub-account of Unearned Revenue)

2. Why Use Deferred Revenue? (ASC 606)

Properly recognizing deferred revenue ensures your financial statements accurately reflect when services are delivered, aligning with GAAP (ASC 606).

Cash Basis vs. Accrual for Retainers

Understanding the difference is critical for compliant reporting.

Accrual Basis (Recommended):
  • Recognizes revenue as services are performed.
  • Provides accurate matching of revenue to expenses.
  • Required for GAAP compliance.
Cash Basis (Not for Retainers):
  • Recognizes revenue only when cash is received.
  • Can distort true financial performance.
  • Not GAAP compliant for retainers.

Expert Tip: For businesses receiving advance payments for services, adhering to accrual accounting principles by utilizing a deferred revenue liability account is crucial. This ensures that your revenue recognition matches the delivery of services, not just the receipt of cash.

3. Step-by-Step: Recording Unearned Revenue

Here is the high-level workflow for correctly managing service retainers.

The core principle is to initially record the retainer as a liability, then gradually move it to income as services are provided over time.

Here is a sample journal entry structure for receiving a retainer.

{
  "date": "2025-01-15",
  "transaction_type": "Retainer Received",
  "entries": [
    { "account": "Cash in Bank", "type": "Debit", "amount": 5000.00 },
    { "account": "Unearned Revenue", "type": "Credit", "amount": 5000.00 }
  ],
  "description": "Initial retainer payment from Client XYZ"
}

4. Journal Entry Walkthrough

  1. 1

    Record the Initial Retainer Payment

    When you receive a retainer from a client, debit your Bank account (asset) and credit your Unearned Revenue account (liability). This reflects cash received for services yet to be performed.

  2. 2

    Create an Amortization Schedule

    Based on your service agreement, determine how much of the retainer will be recognized as revenue each month. This could be a fixed amount, hourly, or percentage-based.

  3. 3

    Recognize Revenue Monthly

    At the end of each period (e.g., month-end), create a journal entry: Debit Unearned Revenue (decreasing the liability) and Credit Service Revenue (recognizing the earned portion).

Common Error: Booking Retainers Directly to Income

Depositing a client retainer directly to an Income account (e.g., “Sales” or “Service Revenue”) upon receipt is incorrect for accrual basis. It must first go to a Liability account (Unearned Revenue).

5. Monthly Reconciliation

Deferred Revenue Checklist

  • Verify the opening balance of Unearned Revenue.
  • Confirm all new retainer receipts are posted correctly.
  • Review all monthly revenue recognition entries.
  • Ensure the ending balance reflects services still owed.
  • Match recognized revenue to actual service delivery.

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