Deferral Adjustment

To defer means to postpone or delay. Deferral are Costs or revenues that are recognized at a date later than the point when cash was originally exchanged. Companies make deferral adjustment to record the portion of the deferred item that was incurred as an Expenses or earned as Revenue during the current accounting period. The two types of deferral are:

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Prepaid Expenses

Expenses paid in cash and recorded as assets until they are used or consumed are Called Prepaid Expenses. This is first type of  deferral adjustment. Prepaid expenses are costs that expire with the passage of time (i. e. rent and insurance) or through use (i. e. supplies). Expenses are paid in advance are called prepaid expenses or unexpired expenses. Cost always has two parts one is expired and other on is unexpired. It is not unlikely that some expenses may have been paid in advance.

Companies record payments of expenses that will benefit more than one accounting. Examples of common prepayments are insurance, supplies, advertising, and rent. In addition, companies make prepayments when they purchase buildings and equipment. Prepaid expenses are costs that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies). The expiration of these costs does not require daily entries, which would be impractical and unnecessary.


Example # 1:

On September 1, 2015 full year insurance paid of Rs. 24,000.

 

Solution:

We will utilize this expense for 12 months and we have 4 months expense for 2015 and remaining for 2016. Prepaid expenses has two cases on the basis of journal entry and Trial Balance presentation.

  1. Expense Method
  2. Asset Method

 

Case 1: Expense Method

Under Expense Method of deferred adjustment, following Journal Entry is pass as routine matter at September 1, 2015:

prepaid expenses journal entry

in above journal entry all complete amount of insurance is consider as expense. The effect of above regular entry in end of year trial balance (at he end of December, 2015) is presented below:

trial balance partial

So adjusting entry at December 2015 in order to adjust the balance is presented below:

journal entry for prepaid expenses

Case 2: Asset Method

Under Asset Method of deferred adjustment, all amount consider as an Assets, following journal entry is pass as routine matter at September 1, 2015:

prepaid expenses journal entries

The effect of above regular entry in end of year trial balance is presented below:

trial balance

So adjusting entry at December 2015 in order to adjust the balance:

prepaid expenses example

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Unearned Revenue

Unearned Revenue is second type of deferral adjustment. Income received in advance but has not been earned in accounting period is called Unearned Revenue. There are some items of Income Statement such as interest, rent, discount etc. etc. which might have been received in advance for which the services in full has not been given so for. Companies record cash received before Revenue is earned by increasing (crediting).

 

Example # 2:

Rent received for four year in January 01, 2016 of Rs. 80,000?

Solution: 

At the end of 2016 accounting period only one year rent is recognized as revenue and remaining Liabilities for next accounting year:

Case 1. Revenue Method

unearned revenue

The effect of above regular entry in end of year Trial Balance is presented below:

unearned revenue is what type of account

So Adjusting Entry at December 2016 in order to adjust the balance is show below:

unearned revenue journal entry

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Case 2: Liability Method

what is unearned revenue

The effect of above regular entry in end of year trial balance is presented below:

unearned revenue is what type of an account

So adjusting entry at December 2016 in order to adjust the balance:

unearned revenue meaning

Deferred…Expenses…Assets…Prepayments

Deferred…Revenue…Liability…Unearned

 

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