A deferral is a delay in the recognition of a revenue or expense transaction.
Deferred revenue is revenue which is not yet earned. Deferred revenue creates a performance obligation to the company – i.e., the company is obligated to provide the goods or services for which the payment was made. As such, deferred revenue is recorded as a liability in the company’s books. As the company delivers the goods or services, revenue is recorded. Generally, deferred revenue is recognized as a current liability. However, some long-term contracts may require the recognition of a portion of deferred revenue as a long-term liability.
For an example of deferred revenue, consider a software company that sells a one-year license to a business customer. The one-year subscription is for $12,000 and is paid in advance. When the software company receives the upfront payment, the company debits a cash account and credits a deferred revenue account. Each month, the company has “earned” 1/12th of the prepayment and will recognize revenue in the amount of $1,000. The accounting entry for recognizing one-month of revenue is to credit a sales account and debit the deferred revenue account.
Deferred expenses, in contrast, represent payments the company made to a vendor for goods or services not yet consumed. The company will record the deferred expense as an asset. The company recognizes the expense over time as the expense is consumed. Expenses are also deferred when they are capitalized into the cost of a long-term asset.
