A deferred expense is a cost that has already been incurred, but which has not yet been consumed. The cost is recorded as an asset until such time as the underlying goods or services are consumed; at that point, the cost is charged to expense. A deferred expense is initially recorded as an asset, so that it appears on the balance sheet (usually as a current asset, since it will probably be consumed within one year).
From a practical perspective, it makes little sense to defer the expenses associated with smaller amounts of unconsumed goods and services, since the accountant 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 approach 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.