Deferral
Encyclopedia
Deferred, in accrual accounting, is any account where the asset
or liability is not realized until a future date (accounting period
), e.g. annuities
, charges
, tax
es, income
, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual
.
Unfortunately, the term deferral is also often used as an abbreviation for the terms deferred expense and deferred revenue that share the common name word, but they have the opposite economic / accounting characteristics.
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
, advertising
campaigns, etc., and are carried as a non-current asset
on the balance sheet
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
realization) and cannot be used in reducing total liabilities.
used to enable cash paid out to a counterpart for goods or services to be received in a later accounting period
when fulfilling the promise to pay is actually acknowledged, the related expense
item is recognized, and the same amount is deducted from prepayments. It shares characteristics with accrued revenue (or accrued assets) with the difference that an asset to be covered latter are proceeds from a delivery of goods or services, at which such income item is earned and the related revenue
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 period
s are monthly, an 11/12 portion of an annually paid insurance
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
, 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
(profit and loss or P&L) as the expense
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.
) 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
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 fee paid out by a customer upfront on the January 1. However the company's fiscal year 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
for that year.
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
or liability is not realized until a future date (accounting period
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
), e.g. annuities
Annuity (finance theory)
The term annuity is used in finance theory to refer to any terminating stream of fixed payments over a specified period of time. This usage is most commonly seen in discussions of finance, usually in connection with the valuation of the stream of payments, taking into account time value of money...
, charges
Fee
A fee is the price one pays as remuneration for services. Fees usually allow for overhead, wages, costs, and markup.Traditionally, professionals in Great Britain received a fee in contradistinction to a payment, salary, or wage, and would often use guineas rather than pounds as units of account...
, tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es, income
Income
Income is the consumption and savings opportunity gained by an entity within a specified time frame, which is generally expressed in monetary terms. However, for households and individuals, "income is the sum of all the wages, salaries, profits, interests payments, rents and other forms of earnings...
, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual
Accrual
Accrual of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting...
.
Unfortunately, the term deferral is also often used as an abbreviation for the terms deferred expense and deferred revenue that share the common name word, but they have the opposite economic / accounting characteristics.
- Deferred expense: Expense is recognized after cash is paid out.
- Deferred revenue: Revenue is recognized after cash is received.
Deferral (deferred charge)
Deferred charge(or deferral) is costCost
In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this...
that is accounted-for in latter accounting period
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
for its anticipated future benefit, or to comply with the requirement of matching
Matching principle
The matching principle is a culmination of accrual accounting and the revenue recognition principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, expenses are recognized when obligations are incurred The matching principle...
costs with revenues. Deferred charges include costs of starting up
Startup company
A startup company or startup is a company with a limited operating history. These companies, generally newly created, are in a phase of development and research for markets...
, obtaining long-term debt
Debt
A debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
, advertising
Advertising
Advertising is a form of communication used to persuade an audience to take some action with respect to products, ideas, or services. Most commonly, the desired result is to drive consumer behavior with respect to a commercial offering, although political and ideological advertising is also common...
campaigns, etc., and are carried as a non-current asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
on the balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
pending amortization
Amortization
Amortization is the process of decreasing, or accounting for, an amount over a period. The word comes from Middle English amortisen to kill, alienate in mortmain, from Anglo-French amorteser, alteration of amortir, from Vulgar Latin admortire to kill, from Latin ad- + mort-, mors death.When used...
.
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
Cash
In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...
realization) and cannot be used in reducing total liabilities.
Deferred expense
Deferred expense (or prepaid expense, prepayment) is an assetAsset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
used to enable cash paid out to a counterpart for goods or services to be received in a later accounting period
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
when fulfilling the promise to pay is actually acknowledged, the related expense
Expense
In common usage, an expense or expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often...
item is recognized, and the same amount is deducted from prepayments. It shares characteristics with accrued revenue (or accrued assets) with the difference that an asset to be covered latter are proceeds from a delivery of goods or services, at which such income item is earned and the related revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
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 period
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
s are monthly, an 11/12 portion of an annually paid insurance
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
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
Expense
In common usage, an expense or expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often...
, 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
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
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
Income statement
Income statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
(profit and loss or P&L) as the expense
Expense
In common usage, an expense or expenditure is an outflow of money to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often...
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 incomeDeferred income
Deferred income is, in accrual accounting, money received for goods or services which have not yet been delivered...
) is a liability, such as cash received from a counterpart for goods or services that are to be delivered in a later accounting period
Accounting period
An accounting period is a period with reference to which United Kingdom corporation tax is charged. It helps dictate when tax is paid on income and gains...
. When such income item is earned, the related revenue
Revenue
In business, revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. In many countries, such as the United Kingdom, revenue is referred to as turnover....
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 fee paid out by a customer upfront on the January 1. However the company's fiscal year 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
Profit and Loss
Profit and Loss may refer to:* Profit & Loss, monthly business magazine founded in July 1999 especializing in Foreign exchange market and derivative markets...
for the fiscal year the fee was received. The rest is added to deferred income
Deferred income
Deferred income is, in accrual accounting, money received for goods or services which have not yet been delivered...
(liability) on the balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
for that year.
See also
- Deferred taxDeferred taxDeferred tax is an accounting concept , meaning a future tax liability or asset, resulting from temporary differences or timing differences between the accounting value of assets and liabilities and their value for tax purposes.- Temporary differences :Temporary differences are differences between...
- Revenue recognitionRevenue recognitionThe revenue recognition principle is a cornerstone of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized...
- Matching principleMatching principleThe matching principle is a culmination of accrual accounting and the revenue recognition principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, expenses are recognized when obligations are incurred The matching principle...
- Accruals in accounting