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A deferred expense is a type of payment that has been tendered, either as payment on a debt or to make some sort of essential purchase, but will not be reported as an expense until some later point in time. Companies sometimes use this approach as part of their basic accounting approach, allowing them to absorb the expenses in a future accounting period rather than doing so during the period in which the payment was actually made. This strategy is sometimes used as a means of arranging finances in a manner that makes it possible to account for the expense during a time when the company is expected to experience a higher amount of income.
One of the more common approaches to using a deferred expense strategy is with expenses that are prepaid. For example, if the company has an insurance policy that allows for premiums to be prepaid, the decision may be made to pay six months of premiums at one time. The total amount of the payment is accounted for in the company’s financial records as a prepaid expense, which is incrementally reduced each successive month as a portion of that expense is claimed until it is completely exhausted.
For example, if the business tenders an insurance payment of $18,000 US dollars in the month of December as a means of paying the upcoming premiums for January through June, that $18,000 USD is accounted for on the company balance sheet, deferring it as prepaid insurance. Each month, $3,000 USD of that deferred amount is expensed from that total, until the total amount of the prepaid insurance line item is moved to the company income statement. This initial recording on the balance sheet and the incremental transfer to the income statement is sometimes referred to as adjusting the entries.
The same general approach of using a deferred expense method can be utilized to manage expenses associated with major projects, such as issuing bonds or stocks. Rather than reporting the entire scope of fees in one accounting period, the costs are carried on the balance sheet as a deferred expense, then gradually moved over in increments over several successive periods. This approach allows the company to gradually account for the expenses as the bonds move closer to maturity, with the final amount of the costs appearing on the income statement at the same time that the bonds do mature. Doing so allows the company to recognize the deferred expense even as it is posting earnings in the form of revenues from those bond issues.
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