Deferrals: Prepaid Expenses & Unearned Revenue

Concept

What Are Deferrals?

Deferrals occur when cash is exchanged before the revenue is earned or the expense is incurred. They involve postponing recognition. The two main types are prepaid expenses (assets) and unearned revenue (liabilities).

Example

Prepaid Insurance

A company pays $12,000 for a 12-month insurance policy on January 1. Initially recorded as Prepaid Insurance (asset). Each month, an adjusting entry moves $1,000 from the asset to Insurance Expense: Debit Insurance Expense $1,000, Credit Prepaid Insurance $1,000.

Example

Unearned Revenue

A magazine publisher receives $240 for a 12-month subscription. Initially recorded as Unearned Revenue (liability). Each month: Debit Unearned Revenue $20, Credit Subscription Revenue $20.

Key Point

Remember

Prepaid expenses start as ASSETS and are gradually expensed. Unearned revenues start as LIABILITIES and are gradually recognized as revenue.

Cash vs. Accrual Accounting

Accruals: Accrued Revenues & Accrued Expenses

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