What Deferred Revenue Is in Accounting, and Why It’s a Liability

This is so because per accrual accounting, the recognition of revenue is not complete. As the fiscal year progresses, the company sends the newspaper to its customer each month and recognizes revenue. Monthly, the accountant records a debit entry to the deferred revenue account, and a credit entry to the sales revenue account for $100.

The most common example is depreciation expense, gain/loss on sale of properties, etc. No, in cash basis accounting revenue is reported only after it has been received. As well, expenses in cash basis accounting are recorded only when they are paid. This account needs to be adjusted, and a quick look at the ledger account reveals what is a long-term liability that none of the supplies used up during the year were recorded as expenses. We pay for the supplies so we have them on hand when we need them, and then expense them as we use them. In this accounting system, however, we expense them when we get around to it, which is just before we create the financial statements.

  • Deferred taxes can be assets or liabilities, depending on the nature of the items.
  • Deferral, in general, means a company’s prepaid expenses or revenues.
  • The advantage here is that expenses are recognized, and net income is decreased, in the time period in which the benefit was realized instead of whenever they happened to be paid.
  • A company may capitalize the underwriting fees on a corporate bond issue as a deferred charge, subsequently amortizing the fees over the life of the bond issue.
  • She fills out a little worksheet that you designed and puts in on your desk on her way out to her New Year’s Eve party.

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. Because of the similarity between deferrals and their corresponding accruals, they are commonly conflated. Deferred revenue, on the other hand, refers to money the company has received as payment before a product or service has been delivered. For example, a tenant who pays rent a year in advance may have a happy landlord, but that landlord must account for the rental revenue over the life of the rental agreement, not in one lump sum.

Another example of a deferred expense is a $12,000 insurance premium paid by a company on December 27 for insurance protection during the upcoming January 1 through June 30. On December 27, the $12,000 is deferred to the balance sheet account Prepaid Insurance, which is a current asset account. Beginning in January it will be moved to Insurance Expense at the rate of $2,000 per month. The deferral was necessary to match the $12,000 to the proper year and months that the insurance is expiring and the company in receiving the insurance protection. Technically, when recording a deferral, the prepayment is accompanied by a related recognized expense in the following accounting period, whereas the same amount is deducted from the prepayment.

What Is Deferred Tax?

Having understood the concepts of deferred revenue and deferred expense, let us now move on to the next section. Because it is technically for goods or services still owed to your customers. Let’s assume that a large corporation spends $500,000 in accounting, legal, and other fees in order to issue $40,000,000 of bonds payable. Instead of charging the $500,000 to expense in the year that the fees are paid, the corporation will defer the $500,000 to the contra liability account Bond Issue Costs. Then over the bonds’ life of 25 years, the $500,000 will be amortized (systematically moved) to expense at the rate of $20,000 per year ($500,000 divided by 25 years).

Deferred revenue is most common among companies selling subscription-based products or services that require prepayments. In November, Anderson Autos pays the full amount for the upcoming year’s subscription, which is $602. Now, the accounting department of Film Reel can’t allocate the $602 to sales revenue on its income statement. It can’t, because the magazines haven’t been produced yet, so the cost of goods sold (the costs related to production) cannot be included.

What Is the Difference Between an Accrual and a Deferral?

The deferred item may be carried, dependent on type of deferral, as either an asset or liability. We must note that an adjusting journal entry is done at the end of the accounting period to recognize if it is an expense or an income that the company has incurred. Deferral, in general, means a company’s prepaid expenses or revenues. A deferral can also be defined as an account where the expenses or revenue is not recognized until the order ends on the balance sheet.

Accounting for Deferred Expenses

NetSuite has packaged the experience gained from tens of thousands of worldwide deployments over two decades into a set of leading practices that pave a clear path to success and are proven to deliver rapid business value. With NetSuite, you go live in a predictable timeframe — smart, stepped implementations begin with sales and span the entire customer lifecycle, so there’s continuity from sales to services to support. Accrued revenue are amounts owed to a company for which it has not yet created invoices for. It can be clearly seen that the machinery was written off for tax return in three years, whereas it took 5 years in the financial statement to right off the taxes. The depreciation method used for the tax return is a three-year write-off. Whereas the company uses the straight-line method for internal reporting.

Anderson Autos is a company with 8 car dealerships in the Seattle, Washington area. Anderson provides each of his dealerships with magazine and newspaper subscriptions so that customers have something to read while waiting. To get a discount, Anderson pays the full subscription amounts in advance of the renewals. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.

What can deferred expenses be used for?

If the revenue or expense is not incurred in the period when cash/payment is exchanged, it is booked as deferred revenue or deferred charges. The accrual method is required for businesses with average annual gross receipts for the 3 preceding tax years of $25 million or more. Like deferred revenues, deferred expenses are not reported on the income statement. Instead, they are recorded as an asset on the balance sheet until the expenses are incurred.

Under the cash basis of accounting, deferred revenue and expenses are not recorded because income and expenses are recorded as the cash comes in or goes out. This makes the accounting easier, but isn’t so great for matching income and expenses. Learn more about choosing the accrual vs. cash basis method for income and expenses. Deferred expenses, similar to prepaid expenses, refer to expenses that have been paid but not yet incurred by the business.

Each month, the landlord uses a portion of the funds from deferred revenue and recognizes this portion as revenue in the financial statements. As is the case with deferred charges, deferred revenue ensures that revenues for the month are matched with the expenses incurred for that month. Deferred revenue is common with subscription-based products or services that require prepayments. Examples of unearned revenue are rent payments received in advance, prepayment received for newspaper subscriptions, annual prepayment received for the use of software, and prepaid insurance. 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.

Once companies consume the related service or product for it, they can transfer the asset to the income statement. Once the company obtains the product or service for which it has made an advance payment, it can write off the asset. At this point, it no longer stays as an asset on the balance sheet. Deferred expenses may also become a part of other assets, for example, in the case of borrowing costs capitalized as fixed assets.

She fills out a little worksheet that you designed and puts in on your desk on her way out to her New Year’s Eve party. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers.

Deferred Expenses vs. Prepaid Expenses: What’s the Difference?

Deferred expense refers to spending for which the company has not incurred the expense. It applies in various areas due to the accrual principle in accounting. Despite being known as a deferred expense, it is an asset in the initial stage.

As an example of a deferred expense, ABC International pays $10,000 in April for its May rent. It defers this cost at the point of payment (in April) in the prepaid rent asset account. In May, ABC has now consumed the prepaid asset, so it credits the prepaid rent asset account and debits the rent expense account. A deferred expense is a cost that has already been incurred, but which has not yet been consumed. The cost is recorded as an asset until such time as the underlying goods or services are consumed; at that point, the cost is charged to expense. A deferred expense is initially recorded as an asset, so that it appears on the balance sheet (usually as a current asset, since it will probably be consumed within one year).

This makes the amount a revenue or an expense that will reflect in the balance sheet only when the delivery of services has taken place. Below is an example of a journal entry for three months of rent, paid in advance. In this transaction, the Prepaid Rent (Asset account) is increasing, and Cash (Asset account) is decreasing.