A deferral accounts for expenses prepaid or early receipt of income. In other words, it is paid for goods or services not yet given or obtained by them. A deferment shall cause the expenses or revenues, later in the same duration of the delivery, to be shown on the financial statement.
Here’s What We’ll Cover:
- What is a Deferral in Accounting?
- What Is the Difference Between an Accrual and a Deferral?
- Why Defer Expenses and Revenue?
- Is Deferred Revenue a Credit or Debit?
What Is a Deferral in Accounting?
In accounting, that means deferring or delaying until later, a more suitable time to identify those revenues and expenditures on the income statement. Revenues shall be deferred until it is paid in a later date to a balance sheet liability account. Once revenue is generated, the revenues on income statements are shifted from the balance sheet account.
Expenses shall be deferred until they have been reconciled, expired, or matched to revenue in a balance sheet. They would then be transferred to an expense with the statement of income.
A deferral refers to the money that is spent or earned before a good or service is delivered. Such examples of deferrals are as follows:
- Insurance premiums
- Subscription-based services (newspapers, magazines, television programming, etc.)
- Prepaid rent
- Deposits on products
- Service contracts (example: cleaners)
- Tickets for sporting events
What Is the Difference Between an Accrual and a Deferral?
An accrual concerns the following:
- Expenses which have not been recorded or decided to pay but should be recorded now;
- Revenues which should now be recorded but not yet reported and not received the money.
- Example of an Expense Accrual:
Accrual of the expenses or an expense accrual applies to the reporting of an expense and associated liability in an accounting period prior to the payment or receipt of the seller’s invoice. The electricity used in December, where neither payment nor bills are processed until January, is an example of expense accrual. The electricity in December shall be marked with the accrual adjustment entry of December 31, debiting the electricity expenditure and crediting the liability account, such as the accrued expenses payable.
- Example of a Revenue Accrual:
Revenue accrual or accrual of revenues refers to the reporting of revenue and the associated assets over the earnings and before sales or receiving the money. The accrual of revenues is an instance of a bond investment interest gained in December, but the money is not obtained later. Such interest should be reported for an accrual adjustment entry on December 31, debiting interest receivable and credits interest income.
Definition of a Deferral
If an organization has a deferral:
- payout money that is due in the future accounting period as an expense and/or
- money earned to be reported as revenue in the corresponding accounting period
- Example of an Expense Deferral:
A deferral of an expense or expense requires advance payment in the accounting period(s) for which this is taken of an expense. An illustration of this is the payment made for property insurance in December for the next six months from January to June. The amount not yet expired should be reported as a current asset such as prepaid insurance or prepaid expenses. Insurance expenses should be reported as the balance expiring in an accounting year.
- Example of a Revenue Deferral:
A deferral of revenues or revenue deferral means capital earned in advance. An example is the insurance business that will collect money for insurance protection for the next six months in December. The insurance company should disclose the outstanding balance as a current liability, for instance, Unpaid Insurance premiums, before the amount is earned. For insurance premiums earned, the statement of income should be stated as Insurance Premium Revenues.
Why Defer Expenses and Revenue?
A business shall defer expenditures and revenue to ensure the consistency of its financial statements. That is to conclude:
- For a seller, the revenue for a product is paid for simultaneously with the cost of manufacturing.
- When the product is used, a buyer is responsible for costs for the product.
Using an example of the seller. This time we’ll look at one of Anderson Automakers’ magazine subscriptions. This publication is called “Film Reel” and it’s a nationwide magazine for entertainment. It reflects on content from films about to be released in cinema.
The whole cost of the coming year’s subscription is $602 for Anderson Autos in November. Film Reel’s accounting department cannot still add $602 to the income statement sales revenues. This cannot be achieved because the magazines have not been produced, so it is not possible to add the cost of the goods sold (the costs involved with production).
The distribution of income to sales does not sound like much for one subscription but think about doing it for a hundred or a thousand subscriptions. The income would be increased and the managers of the company would not have a clear image of expenses versus revenue.
Rather, the figure is classified as a liability on the balance sheet of the magazine. When the sales revenue will be added to the income statement each month during the subscription period, the entire monthly amount will be added before the total subscription is accounted for. The cost of the sold goods would reflect the actual expenses in these same periods in order to produce the issues that had been prepaid.
Is Deferred Revenue a Credit or Debit?
Debits and credits are used to settle their books in the bookkeeping of a business. Debits boost the accounts of assets and expenses and reduce accounts of liability, revenue, or equity. Credits do the opposite.
Any debit entry must have an equivalent credit entry for the same dollar, or vice versa when entering a transaction.