Ratable revenue is income that a company earns gradually over a set period rather than all at once. This usually comes from subscriptions or contracts in which services or goods are provided over time. Instead of counting all the money as earned right away, the company spreads it out to match when the service or product is delivered. This method clarifies the company’s financial health by reflecting when the earnings occur.

Below, we’ll explain how ratable revenue is recorded and reported, how it works in practice, and the business types that use ratable revenue recognition.

What’s in this article?

• How ratable revenue is recorded and reported
  
• Ratable revenue vs. deferred revenue
  
• How ratable revenue works in practice
  
• Types of businesses that use ratable revenue recognition
  

How ratable revenue is recorded and reported

To record and report ratable revenue, a business recognizes income gradually over the period in which it delivers a product or service, rather than all at once.

When a customer pays up front for a service or subscription, the business initially records that payment as deferred revenue on the balance sheet, since it hasn’t yet fully provided the service. As the company fulfills its obligation by delivering the service or product over time, it shifts a portion of this deferred revenue to “earned revenue” on the income statement. This continues until the entire amount has been recognized.

This process ensures that the revenue aligns with the period in which it is earned, providing a more accurate and consistent reflection of a company’s financial performance.

Ratable revenue vs. deferred revenue

Ratable revenue and deferred revenue are closely related concepts in accounting, but they refer to different stages of the revenue recognition process. Ratable revenue is income that is recognized gradually as the service is provided, while deferred revenue is income that has not yet been recognized since the goods or services have not yet been delivered.

Here’s what businesses should know.

Ratable revenue

Ratable revenue is revenue that is recognized evenly over the period of a contract or agreement. Companies often use this method for subscriptions or services provided over a specific time frame. The key characteristic of ratable revenue is even income distribution across the duration of the service or subscription period, which matches revenue recognition to the delivery of value or service to the customer. Ratable revenue affects the income statement as it is recognized by showing a steady flow of income.

• Example: If a company sells an annual software subscription for $1,200, ratable revenue recognition allows the company to recognize $100 per month, reflecting the ongoing provision of the software service.
  

Deferred revenue

Deferred revenue, also known as unearned revenue, refers to money that a business receives for goods or services yet to be delivered. Businesses record this revenue type on the balance sheet as a liability, because it represents an obligation to deliver products or perform services in the future. It moves to the income statement as revenue when it is earned.

• Example: When a customer pays up front for a one-year gym membership, the gym initially records the total payment as deferred revenue. As the gym provides access over the year, it gradually recognizes this payment as earned revenue on a monthly basis.
  

How ratable revenue works in practice

The business gradually recognizes ratable revenue as income over the period in which a service or product is delivered. This provides a more accurate picture of financial performance that matches income to the period in which the product or service is delivered. Here’s how this works in practice:

• A customer pays for a service or product in advance. This payment could be for a subscription, a long-term contract, or any service that spans multiple periods. For instance, a customer might pay for a one-year software subscription or a three-year maintenance contract.

• When the company receives payment, it records the full amount as deferred revenue on the balance sheet. Deferred revenue is considered a liability, because the company has an obligation to provide the service or product in the future.

• The business establishes a schedule to recognize the revenue over the service or contract period. This schedule aligns with service delivery or product use. For example, if the customer has paid for a 12-month subscription, the business recognizes revenue monthly over the course of the year.

• At the end of each reporting period (e.g., monthly, quarterly), the company moves a portion of the deferred revenue to “earned revenue” on the income statement. The amount recognized corresponds to the proportion of the service provided during that period. For example, for a 12-month subscription paid in advance, the company recognizes about 8.3% of the total payment as revenue each month.

• As the business recognizes revenue over time, the deferred revenue liability on the balance sheet decreases while the earned revenue on the income statement increases. This regular adjustment continues until the entire deferred amount is recognized as revenue.

• If a customer cancels the subscription or if there are any changes in the contract terms, the company adjusts the revenue recognition schedule accordingly. It might refund any unused portion or might extend or shorten the recognition period.

Throughout this process, businesses must ensure that their revenue recognition practices comply with accounting standards such as Accounting Standards Codification (ASC) 606 and International Financial Reporting Standard (IFRS) 15. These require businesses to recognize revenue when control of the goods or services is transferred to the customer, not when cash is received.

Types of businesses that use ratable revenue recognition

Businesses that use ratable revenue recognition typically share several traits relating to how and when they deliver value to their customers. Here are some of their common traits:

• Subscription or contract-based models: Using subscriptions, retainers, or long-term contracts in which customers pay up front for goods or services delivered over time

• Recurring revenue streams: Relying on recurring payments such as monthly and annual fees (and not one-time sales)

• Continuous or periodic service delivery: Providing services, access, or support continually or at set intervals (e.g., monthly, quarterly)

• Deferred revenue liabilities: Having substantial amounts of deferred revenue on their balance sheets from customers paying in advance for future services

• Long-term customer relationships: Focusing on building long-term relationships and delivering ongoing value to customers, instead of relying solely on one-time transactions

• Compliance with revenue recognition standards: Adhering to accounting standards such as ASC 606 and IFRS 15, which require revenue to be recognized when it is earned and not when it is received

• Complex revenue recognition processes: Requiring sophisticated accounting systems to manage and track revenue recognition accurately, especially when handling multiple products, service tiers, or contract terms

Here are some examples of specific business types that handle ratable revenue:

• Software-as-a-service (SaaS) companies: Businesses with software subscriptions or cloud-based services that customers pay for on a monthly or annual basis

• Telecommunications providers: Companies providing phone, internet, and TV services on monthly or annual contracts

• Insurance companies: Businesses receiving premiums up front for insurance policies that provide coverage over time

• Subscription-based media and entertainment: Companies with streaming services, digital publications, or membership-based businesses that collect fees up front and deliver content or benefits over time

• Professional services firms: Consulting companies, law firms, or accounting companies that work on retainer or on long-term contracts in which payments are made up front and services are delivered over a period

• Education and e-learning platforms: Businesses with online courses, training subscriptions, or academic programs in which fees are collected in advance and learning materials or sessions are provided over a set timeline

• Maintenance and support service providers: Companies with extended warranties, maintenance contracts, or ongoing support services for software or hardware products