What is a Deferral?
Definition: Deferral is a term used in accounting to indicate the postponement of either revenues or expense payments in a given financial period. In general, a deferral is a prepaid revenue or expense that will reflect in the company books on a future date.
Understanding Deferral In Accounting
In accounting, deferral occurs when a business makes advance payments. The fact that the goods or services that the business has paid for will be received at a future date means they can only be acknowledged in the future. Likewise, deferral can occur when customer’s makes payments for future supplies
Deferral ensures expenses and revenues are booked at an appropriate accounting period in the future. Likewise, such actions allow companies and businesses to account for sales only when they take place.
Deferred Revenue
In the case of revenues, deferred revenue acts as advanced payments paid for products and services that a company would have to deliver in the future. In this case, the revenues appear in accounting books as unearned revenue, and a business would have to book them as differed revenue in the balance sheet.
Deferral revenues are credited in a liability account instead of the revenue account. Deferral expenses, on the other hand, are debited to the asset account instead of the expense account.
Likewise, deferred revenue acts as a liability as it is revenue a business is yet to earn’ despite customers making payments. The business will only earn the revenue upon delivering goods and services as agreed with a customer.
Deferred revenue is a liability, as there is always a possibility of a business failing to deliver the goods and services in the future. A customer canceling an order paid for, would essentially force the business to return payment.
Deferral Example
Deferrals mostly occur in a manufacturing setting whereby some payments must be made in advance if a business is to operate year-round. For instance, a firm engaged in the production of consumer goods might have to pay $60,000 as advance rent for 12 months.
In this case, only $5000 would be booked as cost in the first month. The remaining $55,000 would be deferred and appear as prepaid expenses in the books of accounts. The $60,000 paid in advance, in this case, is deferral expense that can only be recognized at different accounting periods, which in this case, is months when the rent is due.
Deferral vs. Accrual
Deferral and accrual are accounting terms that can be confusing. While both are adjusting entries, they differ a great deal when it comes to their impact on a balance sheet. Accrual is used to refer to expenses and revenues that are reported now but are yet to be paid for or received.
Perfect examples of expense accrual pertain to utility bills. For instance, an expense bill incurred in a given month can only be recorded in the following month, even though it is incurred in the current month. Likewise, accrual revenues refer to sales made in a given month, but payments made in the preceding month. For instance, sales made in January with payments scheduled for February amounts to accrual revenues.
Accruals differ from deferral on the fact that it occurs before payments or receipts are made while the latter occurs when payment or receipts are made. Similarly, accruals expenses are already incurred but yet to be paid for while deferral refers to expenses already paid out but yet to be incurred.
Accrual in accounting leads to an increase in revenue and a decrease in costs while deferral leads to a decrease in revenue and an increase in costs, on the other hand. Similarly, accrual system recognizes revenue in income statements before actual payments are made while deferral systems decrease debit accounts while crediting revenue accounts.