Deferred Charge
Definition
A deferred charge, also known as a deferred expense, is an intangible expenditure carried forward as an asset on a company’s balance sheet. This expenditure is then amortized, or written off, over future periods in alignment with the benefit it provides. This accounting practice helps match the costs of the expenditure with the revenues generated, adhering to the matching principle in accounting.
Examples
- Mortgage Arrangement Fees: For instance, fees paid to secure a 30-year mortgage for an income-producing real estate property would be classified as a deferred charge. These fees are then amortized over the life of the mortgage.
- Research and Development Costs: Costs incurred for significant research and development activities can be deferred and amortized over the expected benefit period.
- Prepaid Insurance: Insurance premiums paid in advance for coverage of multiple future accounting periods can be treated as a deferred expense.
Frequently Asked Questions (FAQs)
1. What are deferred charges used for in accounting?
Deferred charges are used in accounting to allocate intangible expenses over the periods they benefit. This practice ensures that expenses are matched with the corresponding revenues, providing a more accurate financial picture.
2. How do you amortize deferred charges?
Deferred charges are amortized by systematically allocating the expense over the useful life of the expenditure. The amortization schedule depends on the duration of the benefit.
3. Is a deferred charge the same as a prepaid expense?
No, while both are similar in nature, a deferred charge is typically a longer-term asset amortized over an extended period, whereas prepaid expenses are shorter-term assets usually recognized within one year.
4. Are deferred charges considered assets or liabilities?
Deferred charges are considered assets. They represent expenses that have paid but are yet to be recognized on the income statement.
5. Can deferred charges apply to tangible assets?
No, deferred charges typically apply to intangible expenditures. Tangible assets are handled through depreciation rather than amortization.
- Amortization: The process of gradually writing off the initial cost of an intangible asset over a period.
- Prepaid Expense: An expense paid in advance and recognized as an asset until the benefit is realized, usually within one year.
- Depreciation: The process of allocating the cost of a tangible asset over its useful life.
- Asset: Resources owned by a company that have economic value and can provide future benefits.
- Liabilities: Obligations and debts a company owes to external entities.
Online References
Suggested Books for Further Studies
- “Financial Accounting” by Paul D. Kimmel, Jerry J. Weygandt, and Donald E. Kieso
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Accounting for Dummies” by John A. Tracy
Fundamentals of Deferred Charge: Accounting Basics Quiz
### What is a deferred charge?
- [ ] A current liability on a balance sheet.
- [x] An intangible expenditure carried forward as an asset.
- [ ] A tangible asset depreciated over time.
- [ ] An immediate expense recognized in the income statement.
> **Explanation:** A deferred charge is an intangible expenditure carried forward as an asset, then amortized over the period it represents.
### Which type of expense would typically be classified as a deferred charge?
- [x] Mortgage arrangement fees for 30 years.
- [ ] Annual office supplies.
- [ ] Monthly utility bills.
- [ ] Weekly employee salaries.
> **Explanation:** Mortgage arrangement fees for an extended period are deferred and amortized over the life of the mortgage, hence classified as a deferred charge.
### How are deferred charges typically treated in accounting?
- [ ] Depreciated.
- [x] Amortized.
- [ ] Expensed immediately.
- [ ] Recorded as a liability.
> **Explanation:** Deferred charges are amortized over the period they benefit, spreading the cost systematically.
### What principle in accounting does the treatment of deferred charges adhere to?
- [ ] Accrual principle.
- [x] Matching principle.
- [ ] Consistency principle.
- [ ] Conservatism principle.
> **Explanation:** Deferred charges adhere to the matching principle, ensuring that expenses are matched with the revenues they generate over time.
### Where on the balance sheet can you typically find deferred charges?
- [ ] Under current liabilities.
- [ ] Under non-current liabilities.
- [x] Under non-current assets.
- [ ] Under equity.
> **Explanation:** Deferred charges are recorded under non-current assets since they will provide benefits over a longer period.
### Can prepaid insurance be a deferred charge?
- [x] Yes, if the insurance coverage spans multiple periods.
- [ ] No, only intangible assets can be deferred charges.
- [ ] Yes, but it is considered a liability.
- [ ] No, insurance costs are never deferred.
> **Explanation:** Prepaid insurance can be classified as a deferred charge if it covers multiple future periods.
### What happens if a deferred charge is not amortized?
- [ ] It remains a constant asset.
- [ ] It becomes a liability.
- [ ] It directly increases revenue.
- [x] It misstates the financial positions and performance over time.
> **Explanation:** Not amortizing deferred charges misstates the company's financial position, as expenses linked to revenue generation are not matched appropriately.
### What is the difference between a prepaid expense and a deferred charge?
- [ ] Prepaid expenses are liabilities, deferred charges are assets.
- [ ] There is no difference.
- [ ] Prepaid expenses are recognized immediately, deferred charges are written off.
- [x] Prepaid expenses are short-term, deferred charges are long-term assets.
> **Explanation:** Prepaid expenses are typically short-term assets, while deferred charges are long-term and amortized over the benefit period.
### Which financial statement principally shows the impact of amortizing deferred charges?
- [ ] Cash Flow Statement.
- [ ] Income Statement.
- [ ] Statement of Retained Earnings.
- [x] Balance Sheet and Income Statement.
> **Explanation:** Amortizing deferred charges affects the Income Statement (as an expense) and the Balance Sheet (reducing the asset over time).
### Why would a company choose to treat an expenditure as a deferred charge?
- [ ] To disguise expenses.
- [x] To appropriately match expenses with revenues over time.
- [ ] To increase immediate profitability.
- [ ] To convert liabilities into assets.
> **Explanation:** Treating an expenditure as a deferred charge helps to match expenses directly with the revenues they generate, maintaining accurate financial records.
Thank you for exploring the concept of deferred charges! This foundational knowledge is crucial for understanding how businesses manage and report their expenditures over time. Happy studying!
