What is a Deferred Credit?

A deferred credit is cash received that is not initially reported as income, because it has not yet been earned. In most cases, a deferred credit is caused by the receipt of a customer advance. This is a situation where a customer pays the seller before the seller has provided it with an offsetting amount of services or merchandise.

Accounting for a Deferred Credit

Since the seller has not yet earned the corresponding amount of revenue, it should instead record the payment as a current liability. Once the seller has provided services or shipped merchandise, it can debit the liability account to eliminate the liability, and credit the revenue account to recognize revenue. At this point, recognition of the credit is no longer deferred.

A deferred credit can also be classified as a long-term liability if it will take more than one year to provide services or merchandise to the customer that provided the payment (as may be the case under a multi-year subscription service). However, this is a rare situation.

If the seller is unable to provide the services or merchandise for which the customer advance was paid, the correct transaction (subject to the terms of the contract) is to pay the customer back, which results in a debit to the liability account and a credit to the cash account. This situation arises when a prepaid customer order is placed on backorder status, and the backordered item cannot subsequently be filled.