Deferred income

Deferred income helps you record revenue when it’s earned, not simply when cash is received. This chapter shows you how to identify payments received in advance, calculate the adjustments needed for financial statements, and prepare the journal entries to create and reverse deferred income.

Learning objectives

By the end of this chapter, you should be able to:

• Apply accrual accounting to deferred income.
• Calculate the adjustments needed for deferred income when preparing financial statements.
• Illustrate the process of adjusting for deferred income when preparing financial statements.
• Prepare manual journal entries and update the general ledger accounts for the creation and reversal of deferred income.
• Identify the impact of deferred income on profit and net assets.
• Report deferred income in the financial statements.

Definitions

Deferred income

These are payments received in advance from customers for goods or services that will be delivered or supplied in a future accounting period.

Deferred income is the opposite of accrued income:

• Accrued income: You’ve delivered the goods or services during the current accounting period, but you haven’t received payment yet.
• Deferred income: You’ve received payment (with or without a formal invoice), but you’ll deliver the goods or services in a later accounting period.

Under the accruals concept (and IFRS 15), you recognise as revenue only the portion of goods or services delivered during the current accounting period.

Any amount that relates to a future period is deferred income (also called unearned revenue). Since the cash has already been received, deferred income is reported as a liability on the statement of financial position. It represents the firm’s obligation to deliver goods or services in the future.

Where the payment for the good or service has been recorded in the books, the revenue will have to be decreased by the deferred income to reflect what relates to the current period.

Journal entry to create deferred income:

Debit: Revenue or income
Credit: Deferred revenue or income

This entry:

• Debits revenue to reduce the amount of income currently reported in the statement of profit or loss.
• Credits deferred income to recognise a current liability on the statement of financial position.

The deferred income balance is the portion of the payment that relates to the future period.

Reversal of deferred income

Deferred income represents the part of the invoice (or payment) that relates to a future period. In the subsequent year, when the goods or services are delivered, that deferred amount now qualifies to be recognised as revenue.

A journal entry is passed to move the balance from the deferred income ledger account into the income or revenue general ledger account.

Journal entry to reverse deferred income:

Debit: Deferred revenue or income
Credit: Revenue or income

Illustration: deferred income

A company prepares its financial statements annually on December 31st. On October 1, 2024, the company received $12,000 from a customer as an advance payment for a 12-month internet subscription covering October 1, 2024, to September 30, 2025. The entire amount was initially recorded as revenue.

Required:

1. Calculate the portion of revenue that relates to the year ended December 31, 2024.

Do you know the answer?

2. Determine the portion that should be deferred as of December 31, 2024.

Do you know the answer?

3. Prepare the adjusting journal entry on December 31, 2024, to record the deferred income. Do you know the answer?

Impact on profit and net assets: Creating the $9,000 deferral reduces 2024 revenue and profit by $9,000. It also reduces net assets by $9,000, because a liability rises while assets stay the same (the cash was already received before the adjustment). When the $9,000 is released as revenue in 2025, profit rises by $9,000 and the liability is removed, so net assets go up again by the same amount.

4. Prepare the reversal journal entry on January 1, 2025 (or monthly, if preferred) to recognise the income relating to the subsequent period. Do you know the answer?

General ledger accounts

If the $12,000 receipt had instead been recorded straight to the liability (Debit: Cash, Credit: Deferred income), the year-end adjustment would run the other way: Debit: Deferred income, Credit: Revenue, for the $3,000 earned in 2024 - the balance remaining in deferred income would still be $9,000.

The deferred income account for the contract, as recorded in the illustration above, looks like this over the two years:

Debit	$	Credit	$
Balance c/d (31 Dec 2024)	9,000	Revenue (31 Dec 2024 adjustment)	9,000
Revenue (reversal, 1 Jan 2025)	9,000	Balance b/d (1 Jan 2025)	9,000

Once the $9,000 balance brought down is reversed into revenue, the deferred income account for this contract closes to zero. In general, revenue recognised for a period equals cash received, plus the opening deferred income balance (now earned), minus the closing deferred income balance (still unearned): $\text{Revenue}=\text{cash received}+\text{opening deferred income}-\text{closing deferred income}$.

Summary

Item	Prepayments (We pay)	Deferred income (We receive)
Cash flow	We pay in advance	We receive in advance
Recorded as	Asset	Liability
Represents	Our right to receive goods/services	Our obligation to deliver goods/services