DEFERRED ASSET: WHAT IS IT, CLASSIFICATION AND EXAMPLES - DUDAS - 2024

The deferred tax asset relates to recurring expenses paid in advance, such as insurance, interest or rents are recorded as an asset until the associated service or benefit is received.

It is also known as a deferred charge, deferred cost, or deferred debit. Therefore, it represents an expense that has already occurred, but due to certain circumstances, these costs can be recorded as expenses at a later time.

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The reason for treating certain expenses as deferred assets is that otherwise they would have to be recorded immediately in the expense account, before the related benefit has been used.

This would result in having to recognize excessively high expenses in the initial reporting periods and recognizing excessively low expenses in subsequent periods.

The concept of deferred assets does not apply when a company uses the cash accounting basis, since under this method expenses must be recorded as such as soon as they are paid. Therefore, these items would have to be charged immediately to the expense account.

What is a deferred asset?

Businesses have the opportunity to prepay certain expenses associated with the business. This creates an accounting record on the balance sheet, known as a deferred asset.

For accounting purposes, deferred assets are recorded on the company's balance sheet and will also affect the company's income statement each time the corresponding adjustments are made.

Since a business does not immediately receive the benefits of its purchase, deferred assets are recorded as assets on the company's balance sheet until the expense is executed.

As the company takes these expenses into account, it transfers them to the income statement, reducing the final balance of the deferred asset. The advantage here is that spending is spread more widely, with less effect on net income in a particular month.

Transfer to expenses

It's easy to forget about the items that make up deferred assets on the balance sheet. This often has the consequence that there tends to be a large amortization of the balance of these items at the end of the year, when the auditors begin to examine these accounts.

To avoid this potentially large adjustment, all deferred asset items should be tracked, reconciling at the end of each period their amounts to the account balance on the general ledger and adjusting the balance of that account with a periodic charge to expenses, as needed.

To avoid the work associated with tracking deferred assets, consider adopting an accounting policy whereby expenses that fall below a minimum amount are automatically charged to expenses.

Classification

Prepaid expenses

The expense is made in advance and the paid item is expected to be consumed in a few months.

This deferred asset is recorded as a prepaid expense, so it initially appears on the balance sheet as a current asset. It is classified as a prepaid expense.

Many purchases that a business makes in advance can be classified as prepaid expenses. They are those that a company uses or consumes within a year of purchase, such as insurance, rents or taxes.

Until the profit from the purchase is executed, the prepaid expenses are listed on the balance sheet as a current asset.

For example, if a company pays $ 30,000 for the rental of the premises in December from January to June, then the company can include this total amount paid in its current assets in December as a prepaid expense.

As each month passes, the prepaid expense account for the rent will decrease by the monthly amount of rent, until the total $ 30,000 is consumed.

Deferred expenses

Deferred expenses fall into the category of long-term assets. Expense is run in advance and the paid item is not expected to be fully consumed until a certain number of accounting periods have elapsed.

In this case, the deferred asset is recorded on the balance sheet as a long-term asset. It is classified as a deferred expense.

Deferred expenses are intangible. They arise for a variety of reasons, such as the purchase of particularly large property and casualty insurance, which will protect some aspect of the company's assets from certain events that occur in the future.

The difference with prepaid expenses is that when companies prepay rent or some other expense, they have the legal right to receive the service. Deferred expense charges have no legal rights attached to them.

Examples

Consulting fee

A corporation is planning to install a new manufacturing unit and they have hired consultants to conduct due diligence.

Let us assume that the life of this new manufacturing unit will be 10 years. The consulting fees total $ 250,000.

The corporation makes the full payment of $ 250,000 at the beginning of the project. However, you will not enter this full amount into the "expense" account.

Instead, it will "defer" the $ 250,000 to the balance sheet accounts as costs of the new project. The company will charge $ 25,000 to the expense account each year, which is $ 250,000 spread over 10 years, of the costs of the new project.

The reason that the total expense is recorded as “deferred expense” is because it provides a better equal treatment to the total expense of $ 250,000 with each annual period, where the newly installed production unit will be used and income will be obtained from it.

Sure Prime

The insurance premium is paid in advance in exchange for coverage for accidents in the coming months or years.

For example, Company A pays the insurance premium for its office building. The premium payment is semi-annual. The total cost of the insurance is $ 80,000. Payments are made in June and December, every year.

In June, the company will pay $ 40,000 for the insurance coverage that it will receive through December. Rather, it has reimbursed $ 40,000 in June for the service that it will consume over the next six months until the next payment due date.

The company will record the $ 80,000 deferred asset as an asset in the first year and charge it as an expense in the second accounting year.

References

1. Steven Bragg (2018). Deferred asset. Accounting Tools. Taken from: accountingtools.com.
2. Harold Averkamp (2019). What is a deferred asset? Accounting Coach. Taken from: accountingcoach.com.
3. Wall Street Mojo (2019). Deferred Expenses. Taken from: wallstreetmojo.com.
4. Joshua Kennon (2018). Deferred Long-Term Asset Charges. The Balance. Taken from: thebalance.com.
5. Melissa Horton (2019). Deferred Expenses vs. Prepaid Expenses: What's the Difference? Investopedia. Taken from: investopedia.com.