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.

Because of the matching principle, you only recognize as revenue 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.

Definitions

Deferred income: Journal entries

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.

The journal entry to pass would be:

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 recognize 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 recognized 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. The journal entry would be:

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?

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

Do you know the answer?

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

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

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