Companies that use accrual accounting are handling certain transactions, such as interest costs or depreciation of a fixed asset or costs related to long-term debt, as deferred expenses. Deferred expenses are also known as prepaid expenses because the buyer is paying for goods and services in advance, before using them.
For example, insurance payments are a deferred expense because the buyer pays the insurance in advance before consuming the coverage. Deferred expense is the expense which has already been paid for by the company in one accounting year but the benefits for such expenses have not been consumed in the same accounting period and it is to be shown in the asset side of the balance sheet of the company.
With that in mind, we can simply say that deferring an expense means postponing the expenses. But this activity of postponing the expense does not mean the expense is not made. Instead, the postponing is done in reporting of that particular expense. You are free to use this image on your website, templates etc, Please provide us with an attribution link How to Provide Attribution? Let us assume that student A is living in a rented house, costing him INR per month. In June, he has extra cash of INR with him and hence, decides to pay the rent in advance for the next two months.
In other words, he has already paid for the service occupying the rented house , which he will consume living in the house in the coming months. For the next two months, the expenditure of INR made will serve as an asset to the student as it is providing him with benefits. It is because out of two months of advances payment made, one-month service has already been availed. Now the asset is available only for next month and worth only INR A corporation is into the manufacturing of handbags and shoes.
This expense, in other words, is an asset for the buyer, until the seller delivers, at which time the buyer incurs owes the expense. Upon delivery of the goods or services, the buyer's deferred asset value becomes 0, replaced with an ordinary expense entry in the accounting system. Applies when there is a long time between payment and goods or services delivery.
Exhibit 1. Six Deferred Expense terms that differ only slightly in meaning. C onsider, for instance, a firm that ships products through the Postal Service. On the first day of each month, the firm buys a month's supply of postage for its postage meter account. This purchase is to cover shipping charges for the forthcoming month.
Before using the postage, the firm carries the expense in an asset account such as Deferred expense, Prepaid expense, or Prepaid postage. Then, as customer mailings go out over the month, the firm transforms the postage cost into ordinary expense with two simultaneous account entries:.
The firm may make such entries daily, weekly, or even monthly. It is essential only that deferred expenses become ordinary expenses in the same accounting period as service consumption. O ther common kinds of deferred expenses appear when a firm pays the following:. Transactions that create a deferred expense sometimes take the name "deferred charge.
The term is also appropriate when there is a very long period between payment and completion of goods or service delivery. For this reason, company "startup expenses," for instance may register as "deferred charges. F irms apply the deferred expense concept to maintain accounting accuracy concerning the "matching concept.
Consider a situation where deferred expense status for a given cost extends across several accounting periods. In that case, declaring the full value as a first-period expense could result in overstating first-period expense.
And, this would, therefore, understate first period profits. The purpose of deferred expenses compares with the intention of depreciation and amortization expenses. Distributing these latter expenses across an asset's depreciable life also avoids overstating expenses in the acquisition period. A ccounting principles sometimes work against each other, in which case accountants must decide which rule takes precedence. Rigorous application of the matching principle, for instance, could work against the materiality principle —the idea that reports should disregard trivial matters.
Items are "material" if they could individually or collectively influence the economic decisions of financial statement users. Consider for instance a business that buys just a few printed postage stamps, or small stocks of office supplies, to use up across several accounting periods. Accountants in such cases will likely decide that recording the cost of every stamp or every pencil as a deferred expense, until using it, would not be worth the trouble.
This kind of attention to minutia adds unnecessary and confusing detail to financial statements. And, it adds tedious and unnecessary work for bookkeepers or data entry clerks. They will no doubt choose instead merely to expense these costs in the purchase period.
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