What Is Deferred Credit?
Money received by a corporation but not immediately recorded as income because it has not yet been earned is referred to as deferred credit. Revenues may only be recorded as earned under the accrual accounting method when the product or service paid for by a customer is provided and the funds can be matched with a relevant expenditure.
Delayed credit, also known as deferred revenue, deferred income, or unearned income, is reported as a liability on the balance sheet. Consulting fees, subscription fees, and any other income source that is intimately linked to future promises fall under this group.
- Deferred credit is income that will be reported at a later period in accordance with accrual accounting principles.
- Most businesses only record revenue when a customer’s purchased product or service is delivered and the funds can be matched with a corresponding expenditure.
- Until the firm performs its duty and the possibility of reneging on an order is eliminated, the payment is recorded as a liability on the balance sheet.
- Deferred credit is primarily used to “smooth” financial records and provide a more realistic picture of corporate activity.
Understanding Deferred Credit
Deferred credit is usually related to advance payments. The client pays the seller in advance for an item or service that will be supplied or performed in the future. This is sometimes referred to as delayed revenue.
Because the firm has yet to offer anything in return for the money it has just received, the payment is normally shown as a current obligation on the balance sheet. Because it reflects an obligation, the payment is classified as a responsibility. Work must still be done to earn that money, and there is a chance that the item or service will not be supplied, or that the buyer will cancel the purchase, in which case the firm may be required to compensate the client, depending on the conditions clearly mentioned in a signed contract.
Revenue is only recorded as earned under the accrual accounting technique, which is the usual accounting practice for most businesses, when the products or services are provided to the buyer—not when they are paid for.
Only until the seller has supplied the services or shipped the item for which it has already been paid can it record the money as revenue. The deferred credit is recognized at this time, and the obligation is eliminated from the balance sheet.
Benefits of Deferred Credit
Deferred credit is mostly utilized for accounting and to “smooth” financial records and provide a more realistic image of corporate activity.
If, for example, all of a company’s membership or subscription payments came in during the first quarter and all items were delivered out in the second, the income statement would clearly be skewed.
Example of Deferred Credit
Book club subscription services are sold by XYZ Corporation. Members pay an upfront all-inclusive price that covers expenses for the book of the month as well as associated shipping.
Members pay for the whole year in advance. When XYZ Corporation receives the payments, they record a delayed credit obligation for the entire amount on their balance sheet. The revenue for that delivery is recorded when the books are delivered, and the amount of the deferred credit obligation is reduced by that amount.
Because most prepayment durations are for 12 months or less, deferred credit is normally reported on the balance sheet as a current obligation. However, in other cases, a consumer may make an upfront payment for products or services that will be provided over a longer period of time, such as with a multi-year subscription service.
In these instances, any item that has already been paid for and is scheduled to be supplied or rendered after more than a year should be placed in the balance sheet’s long-term liability column.
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