Deferred revenue! How to account for it?

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November 17, 2023

by a searcher from Washington University in St. Louis in Chicago, IL, USA

Situation- The business will have deferred revenue of, let’s assume, 100k. The business paid a 10% commission to staff that sold those packages to clients. The business also has a 5% marketing cost overall. This is not a subscription-based business, and therefore, the revenue is recognized as the services are rendered. There is a 12-month expiration policy for clients to use the service they bought or loose it. It’s non refundable upon sale. Historically, 20% will never redeem it.

Owner proposed- will leave inventory to cover the consumable cost + direct labor cost of providing the services post closing. (Preposterous proposal)

Are there standard practices or accounting principles I can leverage in such scenarios, or does this fall under Wild West territory?

This would be debt on balance sheet. If I rendered the services, I should recognize the revenue and the profits related to it. Or do I have to actually use “fair value of the obligation”?

or to make it simple
Deferred revenue- direct sales cost= debit to new owner at closing.

Thoughts?

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commentor profile
Reply by an intermediary
from The University of Chicago in Chicago, IL, USA
Call me. I teach this subject. More details are needed for healthcare services. Recently I worked on a healthcare deal after it had fallen apart. One side was represented by Big 4, other side by a top regional Transaction Advisory CPA firm. On another healthcare deal ($4 M) I represented the seller. Buyer was represented by another Big 4. Same topic that you are asking came up but did not become an issue.
The challenge is not just the logic, but how to convince the buyer, the seller and their respective advisors. Also, one has to address the EBITDA impact.
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Reply by an intermediary
from Babson College in Boston, MA, USA
The most advantageous position for a buyer would be to treat the deferred revenue as debt, so you effectively get the cash that was collected for work not yet delivered. Another approach is to have the cost to deliver said revenue as a debt like item (I.e. cash delivered to you at close). Happy to chat through this topic further if helpful. I run a firm that offers QoE and M&A advisory services. Previously worked at Big4 in transaction services.
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