A deferred expense is a cost that has already been incurred, almost always through the receipt of a supplier invoice, but sometimes through a prepayment, for which the payer should not yet record an expense because it has not yet consumed the related goods or services. You should not charge these items to expense until the point of consumption, which is also presumably when any related revenue will be recognized. This is known as the matching principle.
You should defer the recognition of an expense by initially recording it as an asset, so that it appears on the balance sheet (usually as a current asset). In a later period, when you have consumed the underlying goods or services, shift the amount in the asset account to an expense account.
From a practical perspective, it makes little sense to defer the expenses associated with smaller amounts of unconsumed goods and services, since you must manually enter the deferral in the accounting software (rather than to the pre-set expense account), as well as remember to charge these items to expense at a later date. Instead, charge these items to expense immediately, as long as there is no material effect on the financial statements. This reserves only larger transactions for deferral treatment. A good example of items that are not necessarily consumed at once, but which are charged to expense immediately are office supplies.
As an example of a deferred expense, ABC International pays $10,000 in April for its May rent. It defers this cost at the point of payment (in April) in the prepaid rent asset account. In May, ABC has now consumed the prepaid asset, so it credits the prepaid rent asset account and debits the rent expense account.
Other examples of deferred expenses are:
- Interest costs that are capitalized as part of a fixed asset for which the costs were incurred
- Insurance paid in advance for coverage in future months
- The cost of a fixed asset that is charged to expense over its useful life in the form of depreciation
- The cost incurred to register the issuance of a debt instrument
- The cost of an intangible asset that is charged to expense over its useful life as amortization
You should defer expenses when generally accepted accounting principles or international financial reporting standards require that they be included in the cost of a long-term asset, and then charged to expense over a long period of time. For example, you may have to include the cost of interest in the cost of a constructed asset, such as a building, and then charge the cost of the building to expense over the useful life of the entire asset in the form of depreciation. In this case, the cost of the interest is a deferred expense.
A deferred expense is also known as a prepaid expense.