What is Deferral Accounting?
Deferral accounting involves postponing the recognition of revenue or expenses to a future period, aligning with the matching principle to accurately reflect financial performance.
Example of Deferral Accounting
A company receives $12,000 in advance for a year’s service. It defers this revenue, recognizing $1,000 each month over the year.
How To Calculate Deferral Accounting
Record the initial transaction as a liability (for unearned revenue) or an asset (for prepaid expenses) and gradually recognize the revenue or expense over the relevant period.
- Special Tip: Use deferral accounting to match revenues and expenses in the period they are incurred, providing a more accurate financial picture.
- Advantages
- Ensures revenue and expenses are recorded in the correct period.
- Provides a more accurate reflection of financial performance.
- Helps in compliance with accounting standards.
- Disadvantages
- Can be complex and require careful management.
- Mistakes can lead to financial misstatements.
FAQs
Why is deferral accounting important?
It ensures financial statements accurately reflect the timing of transactions.
What are common deferred items?
Unearned revenue and prepaid expenses.
How does deferral accounting affect cash flow?
It doesn’t affect cash flow but adjusts the timing of revenue and expense recognition.
Can deferred revenue become bad debt?
Yes, if the company cannot deliver the promised goods or services.
