Deferral
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A deferral, in '' accrual accounting'', is any account where the income or expense is not recognised until a future date ( accounting period), e.g. annuities, charges,
tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal person, legal entity) by a governmental organization in order to fund government spending and various public expenditures (regiona ...
es,
income Income is the Consumption (economics), consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be diff ...
, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual. Deferrals are the consequence of the revenue recognition principle which dictates that revenues be recognized in the period in which they occur, and the
matching principle In accrual accounting, the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting and the revenue recognition principle states tha ...
which dictates expenses to be recognized in the period in which they are incurred. Deferrals are the result of cash flows occurring before they are allowed to be recognized under accrual accounting. As a result, adjusting entries are required to reconcile a flow of cash (or rarely other non-cash items) with events that have not occurred yet as either liabilities or
assets In financial accounting Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of Financial statement audit, financial ...
. Because of the similarity between deferrals and their corresponding accruals, they are commonly conflated. * Deferred expense: cash has left the company, but the event has not actually occurred yet. Prepaid expenses are the most common type. For instance, a company may purchase a year of insurance. After six months, only half of the insurance will have been 'used' with another six months of the insurance still owed to the company. Thus, the company records half of the payment as an outflow (an expense) and the other half as a receivable from the insurance company (an asset). * Deferred revenue: Revenue has come into the company, but the event has still not occurred – it is unearned revenue. A magazine company, for instance, may receive money for a one-year subscription. However, the company has not spent the resources in producing and delivering those magazines and thus accountants record this revenue as a liability equal to the amount of cash received. The magazine company, while now having more cash on hand, also now owes a year of magazines. The amount of each magazine that gets delivered is then taken out of liabilities and recorded as revenue during the economic period in which it actually happens, not just when the company gets paid for it.


Deferral (deferred charge)

Deferred charge (or deferral) is
cost In Production (economics), production, research, retail, and accounting, a cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one o ...
that is accounted-for in latter accounting period for its anticipated future benefit, or to comply with the requirement of matching costs with revenues. ''Deferred charges'' include costs of starting up, obtaining long-term
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
,
advertising Advertising is the practice and techniques employed to bring attention to a product or service. Advertising aims to put a product or service in the spotlight in hopes of drawing it attention from consumers. It is typically used to promote a ...
campaigns, etc., and are carried as a non-current
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
on the
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
pending amortization. ''Deferred charges'' often extend over five years or more and occur infrequently unlike prepaid expenses, e.g. insurance, interest, rent. Financial ratios are based on the total assets excluding ''deferred charges'' since they have no physical substance (
cash In economics, cash is money in the physical form of currency, such as banknotes and coins. In bookkeeping and financial accounting, cash is current assets comprising currency or currency equivalents that can be accessed immediately or near-immed ...
realization) and cannot be used in reducing total liabilities.


Deferred expense

A Deferred expense or prepayment, prepaid expense, plural often prepaids, is an
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
representing cash paid out to a counterpart for goods or services to be received in a later accounting period. For example, if a service contract is paid quarterly in advance, at the end of the first month of the period two months remain as a deferred expense. In the deferred expense the early payment is accompanied by a related recognized expense in the subsequent accounting period, and the same amount is deducted from the prepayment. The deferred expense shares characteristics with accrued revenue (or ''accrued assets'') with the difference that an asset to be covered later are proceeds from a delivery of goods or services, at which such income item is earned and the related
revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...
item is recognized, while cash for them is to be received in a later period, when its amount is deducted from ''accrued revenues''. For example, when the accounting periods are monthly, an 11/12 portion of an annually paid
insurance Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to Hedge ( ...
cost is added to ''prepaid expenses'', which are decreased by 1/12 of the cost in each subsequent period when the same fraction is recognized as an
expense An expense is an item requiring an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. Fo ...
, rather than all in the month in which such cost is billed. The not-yet-recognized portion of such costs remains as ''prepayments'' (assets) to prevent such cost from turning into a fictitious loss in the monthly period it is billed, and into a fictitious profit in any other monthly period. Similarly, cash paid out for (the cost of) goods and services not received by the end of the accounting period is added to the ''prepayments'' to prevent it from turning into a fictitious loss in the period cash was paid out, and into a fictitious profit in the period of their reception. Such cost is not recognized in the
income statement An income statement or profit and loss accountProfessional English in Use - Finance, Cambridge University Press, p. 10 (also referred to as a ''profit and loss statement'' (P&L), ''statement of profit or loss'', ''revenue statement'', ''stateme ...
(''profit and loss'' or P&L) as the
expense An expense is an item requiring an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. Fo ...
incurred in the period of payment, but in the period of their reception when such costs are recognized as expenses in P&L and deducted from prepayments (assets) on balance sheets.


Deferred revenue

Deferred revenue (or deferred income) is a liability, such as cash received from a counterpart for goods or services that are to be delivered in a later accounting period. When such income item is earned, the related
revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...
item is recognized, and the ''deferred revenue'' is reduced. It shares characteristics with ''accrued expense'' with the difference that a liability to be covered later is an obligation to pay for goods or services received from a counterpart, while cash for them is to be paid out in a later period when its amount is deducted from ''accrued expenses''. For example, a company receives an annual
software license A software license is a legal instrument (usually by way of contract law, with or without printed material) governing the use or redistribution of software. Under United States copyright law, all software is copyright protected, in both source c ...
fee paid out by a customer upfront on the January 1. However, the company's
fiscal year A fiscal year (or financial year, or sometimes budget year) is used in government accounting, which varies between countries, and for budget purposes. It is also used for financial reporting by businesses and other organizations. Laws in many ju ...
ends on May 31. So, the company using accrual accounting adds only five months' worth (5/12) of the fee to its revenues in profit and loss for the fiscal year the fee was received. The rest is added to '' deferred income'' (liability) on the
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
for that year.


See also

* Deferred tax * Revenue recognition *
Matching principle In accrual accounting, the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting and the revenue recognition principle states tha ...
* Accruals in accounting


References

{{Authority control Corporate taxation de:Rechnungsabgrenzung