Deferred Credit (Deferred Income; Deferred Liability)

Deferred Credit Deferred Income Deferred Liability Accruals Concept Balance Sheet Government Grant Accounting
Deferred Credit represents income received or recorded before it is earned, and it adheres to the accruals concept by being carried forward on the balance sheet until it is matched with the period in which it is earned.
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What is Deferred Credit?

Deferred credit, also referred to as deferred income or deferred liability, represents income that has been received or recorded but has not yet been earned by the business. In accordance with the accruals concept in accounting, this income should not be included in the profit and loss account of the current period. Instead, it is carried forward on the balance sheet as a liability until it can be matched with the period in which it is actually earned.

Examples of Deferred Credit

  1. Government Grant: A typical example of deferred credit is a government grant. The grant amount received or recorded is initially shown as a separate item or under creditors in the balance sheet. Over time, an annual amount is transferred from this deferred credit to the profit and loss account until the entire balance is brought to nil.

  2. Subscription Revenue: Companies that receive subscription fees for services to be delivered over time recognize the revenue over the subscription period. The amount received for future periods is recorded as deferred credit.

  3. Advance Customer Payments: Payments received from customers for goods or services that will be delivered in subsequent periods are recorded as deferred credit and recognized as revenue when the goods or services are actually provided.

  • Accruals Concept: An accounting principle where revenues and expenses are recorded when they are earned or incurred, regardless of when the actual cash transaction occurs.
  • Profit and Loss Account: Also known as the income statement; it shows the company’s revenues and expenses during a specific period.
  • Balance Sheet: A financial statement that presents the financial position of a company at a specific point in time, listing assets, liabilities, and equity.
  • Creditors: Parties to whom money is owed by the business. Deferred credits are typically listed under creditors until the income is earned.

Online References

  1. Investopedia’s Accrual Accounting
  2. Wikipedia’s Deferred Income

Suggested Books for Further Studies

  1. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
  2. “Financial Accounting” by Robert Libby, Patricia Libby, and Frank Hodge
  3. “Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso

Frequently Asked Questions (FAQs)

  1. What is the primary purpose of recognizing deferred credit?

    • The primary purpose is to align revenue recognition with the accruals concept, ensuring that income is matched with the period in which it is actually earned.

  2. Why is deferred credit listed as a liability?

    • Deferred credit is listed as a liability because it represents income received in advance for goods or services that are yet to be delivered; hence, it is essentially an obligation of the business to perform.

  3. When is deferred credit removed from the balance sheet?

    • Deferred credit is removed from the balance sheet and recognized as revenue in the profit and loss account when the related goods or services are delivered or the income is properly earned.

  4. Can deferred credit be for both long-term and short-term periods?

    • Yes, deferred credit can be for both long-term and short-term periods depending on the nature of the advance payments and the timing of the earning of such income.

Accounting Basics: “Deferred Credit” Fundamentals Quiz

### What is deferred credit also known as? - [ ] Accrued income - [x] Deferred income - [ ] Accounts payable - [ ] Unearned revenue > **Explanation:** Deferred credit is also known as deferred income or unearned revenue, as it represents income received but not yet earned. ### Why is deferring credit critical in accounting? - [x] It ensures revenue is recognized based on the accruals concept. - [ ] It simplifies accounting processes. - [ ] It ensures all cash received is immediately recorded as revenue. - [ ] It maximizes short-term earnings. > **Explanation:** Deferred credit is critical because it ensures that revenue is recognized according to the accruals concept, aligning revenue recognition with the period in which the income is earned. ### Where is deferred credit typically reported? - [ ] Profit and loss account - [ ] Cash flow statement - [x] Balance sheet - [ ] Statement of equity > **Explanation:** Deferred credit is reported on the balance sheet as a liability until the income is earned. ### How are government grants related to deferred credit? - [x] Government grants are recognized as deferred credit until earned. - [ ] Government grants are instantly recognized as revenue. - [ ] They are not part of deferred credit. - [ ] They are recorded as an asset. > **Explanation:** Government grants received in advance are treated as deferred credit until they are earned, often by meeting certain conditions or time requirements. ### What happens to deferred credit in the profit and loss account? - [ ] It stays indefinitely. - [ ] It results in immediate expense recognition. - [x] It is transferred as revenue when earned. - [ ] It converts to an asset. > **Explanation:** Deferred credit is transferred to the profit and loss account as revenue in the periods when it is earned. ### Which concept does deferred credit follow? - [ ] Cash basis - [x] Accruals concept - [ ] Conservative accounting - [ ] Gross receipt > **Explanation:** Deferred credit adheres to the accruals concept, ensuring revenue recognition aligns with the period in which income is earned. ### What type of liability is deferred credit initially considered as? - [x] A current or long-term liability - [ ] A contingent liability - [ ] An operating liability - [ ] A speculative liability > **Explanation:** Deferred credit can be considered either current or long-term liability based on the timeline for earning the related revenue. ### When recognizing deferred credit, when does it match revenue? - [ ] Upon receiving cash. - [ ] At the fiscal year-end. - [x] When the associated income is earned. - [ ] When accounts are reconciled. > **Explanation:** Deferred credit matches revenue when the associated income is earned, not necessarily when cash is received. ### How does deferred credit affect the balance sheet? - [x] It increases liabilities. - [ ] It decreases equity. - [ ] It increases assets. - [ ] It does not affect the balance sheet. > **Explanation:** Deferred credit increases liabilities on the balance sheet as it represents income received in advance. ### Which of the following is not an example of deferred credit? - [x] Accounts receivable - [ ] Advance customer payments - [ ] Subscription fees received - [ ] Government grants > **Explanation:** Accounts receivable are not deferred credit; they represent amounts owed to the company, whereas deferred credits represent advance payments or unearned revenue.

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Tuesday, August 6, 2024
Deferred Debit (Deferred Asset; Deferred Expense)
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Deferred Liability January 1, 1
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