A deferral postpones recognizing revenue or expense on an amount whose cash has already moved, or is already owed, and parks it on the balance sheet until the period it belongs to. It runs in two directions. Cash in ahead of the work creates a liability, and cash out ahead of the benefit creates an asset.
The FASB’s conceptual framework defines a deferral in both directions at once. Deferral is the accounting process of recognizing a liability resulting from a current cash receipt (or the equivalent) or an asset resulting from a current cash payment (or the equivalent) with deferred recognition of related revenues, expenses, gains, or losses (FASB Statement of Financial Accounting Concepts No. 8, Chapter 1 (As Amended)).
A deferral can only exist on books kept on the accrual basis, because a cash-basis ledger records the receipt or the payment and has nothing left over to carry. That basis, and the separate accrual method a taxpayer adopts for tax, are both set out in accrual accounting.
Deferred Revenue, the Liability Side
Money arrives before the work is earned, so the business owes performance rather than owning income. Under the US revenue standard, when either party to a contract has performed, an entity shall present the contract in the statement of financial position as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment (FASB Accounting Standards Update 2014-09, paragraph 606-10-45-1).
The liability side of that presentation is what most ledgers label deferred revenue or unearned revenue. How it behaves across a subscription term is worked through in outsourced accounting for SaaS.
Deferred Expense, the Asset Side
Payment runs ahead of the benefit, so the business owns something it has not used up yet. A year of insurance paid in January is an asset in January and an expense across the months it covers. Common examples of deferrals include prepaid expenses and customer deposits (the same concepts statement), one from each side of the balance sheet.
How the Balance Comes Back Off
A deferral on either side comes off on the same condition rather than at a date someone chooses. Recognition of those related elements is deferred until the obligation underlying the liability is partly or wholly satisfied or until the economic benefit underlying the asset is partly or wholly used or lost (the same concepts statement).
In a firm’s workflow that release is an adjusting entry, posted at the point in the close sequence set out in the month-end close checklist.
A Worked Example
Say a firm collects a year of bookkeeping fees from a client up front and delivers the work evenly across the term. On those inputs the firm’s books carry this.
Retainer collected up front 18,000
Earned each month as the work is delivered 1,500
Recognized in revenue after three months 4,500
Deferred revenue still carried as a liability 13,500The liability falls by the monthly amount every time a month of work is delivered, and it is gone once the final month of work is done. Billing rather than collecting changes which account sits opposite the liability, not the liability itself.
Where Book and Tax Part Company
Book and tax do not defer for the same length of time, and the gap is a reconciling item rather than a mistake. An accrual method taxpayer that receives an advance payment during the taxable year shall include such advance payment in gross income for such taxable year, unless it elects otherwise (26 U.S.C. 451(c)(1)).
Advance payment is a defined term there, not a general description. It reaches a payment for goods, services or such other items as the Secretary identifies, where including the whole of it in the year of receipt would already be a permissible method and some part of it is included in revenue in a later year’s financial statement (26 U.S.C. 451(c)(4)(A)).
The election buys one year, not the length of the contract. Whatever part of the payment is not already picked up in the year of receipt goes into gross income in the taxable year following the taxable year in which such payment is received (26 U.S.C. 451(c)(1)(B)).
The regulation sets that same stop in each of its two deferral methods, and both land in the next succeeding taxable year (Treasury Regulation 1.451-8(c)(1)(ii) and (d)(3)(i)). So deferred revenue can sit on the books for the whole length of the contract while the tax deferral runs no further than the year after the payment came in, and only where the election was actually made.
The definition also puts rent, insurance premiums governed by subchapter L and payments with respect to financial instruments outside the term advance payment unless the Secretary provides otherwise, so the election does not reach them at all (26 U.S.C. 451(c)(4)(B)).
What a Deferral Is Not
An accrual is the mirror image, recognizing an amount before the cash moves where a deferral holds one back after it. A deferred tax asset or a deferred tax liability is different again. It measures a future tax effect rather than the timing of a revenue or an expense.
An amount an employee elects to defer into a retirement plan is a third use of the word. A section 409A deferral is a fourth, and Form 1099-MISC carries box 12 for a nonemployee’s deferrals, a box the payer does not have to complete (IRS, Instructions for Forms 1099-MISC and 1099-NEC).
If the deferred revenue and prepaid schedules on your clients’ books are the last thing anyone gets to each close, a trial task puts a block of that work through Accountably’s review chain before your own reviewer relies on it.
