A deferred cost is a cost that you have already incurred, but which you will not charge to expense until a later reporting period. In the meantime, it appears on the balance sheet as an asset. The reason for deferring recognition of the cost as an expense is that you have not yet consumed the item. You may also defer recognition of a cost if you wish to recognize it at the same time as related revenue is recognized, under the matching principle.
For example, if you pay $1,000 in February for March rent, then it is a deferred cost in February, and you initially record it as a prepaid expense. Once March arrives, you consume the asset, and change the asset into rent expense. Other examples of deferred costs are:
- Interest cost that is capitalized as part of a fixed asset
- The cost of a fixed asset that is charged to expense over time in the form of depreciation
- The cost of an intangible asset that is charged to expense over time as amortization
- Insurance paid in advance for coverage in future periods
- The costs incurred to register a bond issuance
You should defer the costs of some expenditures 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 many years in the form of depreciation. In this case, the cost of the interest is a deferred cost.
From a practical perspective, it is customary to charge all smaller costs to expense at once, since they would otherwise require too much effort to track on a long-term basis. Immediate charge-off is only practiced when the impact on the financial results of a business is immaterial.