What is a Deferral?

To keep things simple, a deferral refers to any money that you paid or received before the performance of a service. To break it down further, if you paid in advance for a service, or someone else paid you for a service that you haven’t yet received, then a deferral is in play. Matching payments or receipts to the period in which the service is performed creates accurate records.

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. The insurance company receiving the $12,000 for the six-month insurance premium beginning December 1 should report $2,000 as insurance premium revenues on its December income statement. The remaining $10,000 should be deferred to a balance sheet liability account, such as Unearned Premium Revenues. In each subsequent month the insurance company will record an adjusting entry to reduce the liability account Unearned Premium Revenues by $2,000 and report $2,000 as Premium Revenues on its income statement. Assume that a company with an accounting year ending on December 31 pays a six-month insurance premium of $12,000 on December 1 with insurance coverage beginning on December 1.

By this point, you should have a fairly good understanding of what deferrals are and some practical examples of journal entries required to reflect deferrals.
Please contact the Accounting Department for the correct Banner FOAP number for deferred revenue items.
Deferred revenues and expenses help businesses match their transactions and keep books balanced.
When customers prepay for products or services they won’t receive until later, the payment is recorded as deferred revenue on the balance sheet rather than sales or revenue on the income statement.

Deferred revenue is a liability because it reflects revenue that has not been earned and represents products or services that are owed to a customer. As the product or service is delivered over time, it is recognized proportionally as revenue on the income statement. Gradually, as the product or service is delivered to the customers over time, the deferred revenue is recognized proportionally on the income statement. A debit entry signifies an increase in an asset — something owned — or a decrease in a liability — something owed — while a credit entry to these accounts indicates the exact opposite. While most cash transactions are entered immediately, an entry for revenue or an expense may be entered long after cash is paid or received.

The revenue recognition principle requires that revenue is recorded when the product is sold or the service is provided. When customers prepay for products or services they won’t receive until later, the payment is recorded as deferred revenue on the balance sheet rather than sales or revenue on the income statement. A Deferred expense or prepayment, prepaid expense, plural often prepaids, is an asset representing cash paid out to a counterpart for goods or services to be received in a later accounting period.

Almost every major example of accounting fraud involves the heavy use of capitalized expense to understate costs and inflate earnings. Some also improperly post deferred revenue as earned revenue, but the scope for manipulation using deferred costs is usually far greater. Under generally accepted accounting principles (GAAP), the purpose of deferred accounting is to ensure that financial statements accurately reflect economic reality. Deferral accounting is a type of earnings management in which revenue and expense is recognized in the financial accounts at a later date than when the corresponding cash flow actually occurred.

For instance, when you sell your services to the client a month or so in advance, you will not immediately count that sale as earned revenue, being that you have not yet earned it (provided the service).
The earnings would be overstated, and company management would not get an accurate picture of expenses vs revenue.
Because of the similarity between deferrals and their corresponding accruals, they are commonly conflated.
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Now, this revenue which is also termed unearned revenue is recorded as a liability on the balance sheet.
The year end closing process is used to convert the books from a cash to accrual basis.

Unfortunately for the company, however, the major order fell through and the company was forced to come clean and recognize the loss. Realizing the accounting shenanigans, the company soon ran into problems raising capital. It needed capital because in reality the company ran at a loss and needed cash. This company, however, capitalized the development cost of software it intended to sell to customers. Needless to say, this practice made the company appear vastly more profitable than it really was. Under GAAP, the cost of software development can only be capitalized if the software is intended specifically for internal use.

When customers pay in advance for products or services they won’t receive until later, this payment is recorded as deferred revenue on the balance sheet. The payment is not immediately recognized as sales or revenue on the income statement. This ensures that revenues and expenses are matched to the period when they occur, providing a more accurate picture of a company’s financial performance. The University of San Francisco operates largely on a “cash basis” throughout much of the fiscal year recognizing revenue and expense as cash changes hands. At year end, financial statements are compiled using the “accrual basis” of accounting. The accrual basis of accounting recognizes revenues and expenses when the goods and services are delivered regardless of the timing for the exchange of cash.

Why defer expenses and revenue?

A deferral relates to a financial transaction amount paid or received, while the related service has not yet been performed or received. The purpose of an accounting deferral is to match the revenue xero accounting community or expense to the period the service is performed. Business owners may need to record a deferral transaction whenever a portion of revenue or expense should be applied at a later date.

Deferred Expense Examples

Deferral is also used to describe the type of adjusting entries used to defer amounts at the end of an accounting period. Each month, 1/12th of the total year-long revenue for the service will be recognized once the customer receives the benefit. Suppose a company decided to receive a payment in advance for a year-long subscription service. Having understood the concepts of deferred revenue and deferred expense, let us now move on to the next section. Now, if the company wants to calculate its deferred expenses which are due to the insurance, here is the table that describes the scenario. The difference between deferred revenue and accounts receivable is as follows.

Deferred expense transactions are common in small businesses, and we will cover a few of them here. When you leave a comment on this article, please note that if approved, it will be publicly available and visible at the bottom of the article on this blog. For more information on how Sage uses and looks after your personal data and the data protection rights you have, please read our Privacy Policy.

Why would a business defer expenses or revenue?

In December, the subscription totals will be accounted for as a deferred expense for Anderson Autos, because the products will not be delivered in the same accounting period they were paid for in. The magazine and newspaper companies will consider these amounts to be deferred revenue, because they haven’t actually incurred any expenses yet to produce the actual magazines, although they have been paid for them. As the company fulfills its obligation—whether that’s shipping a product, providing a service, or anything else it was paid to do—it gradually reduces the liability on its balance sheet. Correspondingly, it recognizes that amount as revenue on its income statement. By the time the company has completely fulfilled its obligation, the deferred revenue balance will have been fully shifted to earned revenue.

A deferral of revenues or a revenue deferral involves money that was received in advance of earning it. An example is the insurance company receiving money in December for providing insurance protection for the next six months. Until the money is earned, the insurance company should report the unearned amount as a current liability such as Unearned Insurance Premiums. As the insurance premiums are earned, they should be reported on the income statement as Insurance Premium Revenues.

Does Deferring a Payment Hurt Credit?

Similarly, if the company receives a bill for utilities in June but doesn’t pay it until July, the expense would be recognized in June. The focus here is on the earning of revenue or the incurring of expense, not the movement of cash. A deferral adjusting entry is made at the end of an accounting period to move the deferred amounts to the right accounts. For example, if you have a deferred revenue liability for a 6-month project on your balance sheet, you’d adjust it monthly to move a portion (1/6th each month) from deferred revenue to earned revenue.