Deferred Liability

Definition

Deferred liability, also known as deferred credit, represents a financial obligation that a company has incurred but is not due for payment until a future date. This can occur in various forms, such as unearned revenue or deferred tax liabilities. These liabilities are recorded on a company’s balance sheet and typically arise from prepayments received for goods or services to be delivered in the future.

Examples

Unearned Revenue: A company may receive payment in advance for subscription services or software licenses that are delivered over time. This prepayment is recorded as a deferred liability until the service is rendered.
Deferred Tax Liability: Arises when there are differences between accounting income and taxable income, leading to tax expenses that are expected to be settled in future periods.
Prepaid Rent: When a company receives rent payments in advance, it recognizes this as a deferred liability until the rental period occurs.

Frequently Asked Questions

What is the difference between deferred liabilities and accrued liabilities?

Deferred liabilities are obligations that result from prepayments received for future services or products, while accrued liabilities represent expenses that a business has incurred but not yet paid.

How are deferred liabilities recorded on the balance sheet?

Deferred liabilities are recorded on the balance sheet under the “current liabilities” or “long-term liabilities” section, based on when the payment is due.

Can deferred liabilities affect a company’s financial health?

Yes, deferred liabilities can impact financial health. High levels may indicate the company has significant future obligations to fulfill. Financial analysts often examine these to assess cash flow and future earning potential.

Do deferred liabilities have an impact on cash flow?

Yes, they impact cash flow when they are settled in the future. Initially, cash flow may increase when the company receives the prepayment.

How do deferred liabilities differ from provisions?

Provisions are estimated liabilities of uncertain timing or amount, which are accounted for by recognizing a liability on the balance sheet and an expense in the income statement. In contrast, deferred liabilities are certain amounts received in advance, which will be earned at a future date.

Accrued Liability: A liability for which expenses have been incurred but not yet paid.
Provision: A liability of uncertain timing or amount, set aside by a company to cover future obligations.
Unearned Revenue: Revenue received for goods or services that have not yet been delivered or performed.
Deferred Tax Liability: A tax liability that is payable in the future due to timing differences between accounting and tax recognition.
Prepaid Expenses: Payments made in advance for goods or services to be received or used in the future.

Online References

Suggested Books for Further Studies

“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Comprehensive resource covering a variety of accounting principles, including deferred liabilities.
“Financial Accounting: An Integrated Approach” by Ken Trotman and Michael Gibbins
- Offers insight into the conceptual framework and application of financial accounting, including liability management.
“Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
- A foundational text exploring the principles of accounting, suitable for beginners and professionals.

Accounting Basics: “Deferred Liability” Fundamentals Quiz

### What is an example of a deferred liability? - [x] Unearned Revenue - [ ] Accounts Receivable - [ ] Prepaid Expenses - [ ] Intangible Assets > **Explanation:** Unearned revenue is a deferred liability because it represents payment received for goods or services not yet delivered, and thus, the obligation to deliver these goods/services is recognized as a liability. ### Which section of the balance sheet would you typically find deferred liabilities? - [x] Current Liabilities or Long-term Liabilities - [ ] Shareholder's Equity - [ ] Current Assets - [ ] Retained Earnings > **Explanation:** Deferred liabilities are recorded under current or long-term liabilities on the balance sheet, reflecting future obligations. ### Are deferred tax liabilities considered deferred liabilities? - [x] Yes - [ ] No - [ ] Only in specific circumstances - [ ] They are considered revenues > **Explanation:** Yes, deferred tax liabilities are a type of deferred liability resulting from timing differences between accounting income and taxable income. ### What happens to deferred liabilities when the related goods or services are delivered? - [x] They are reclassified as revenue - [ ] They remain as liabilities - [ ] They are written off - [ ] They are converted into expenses > **Explanation:** When the related goods or services are delivered, the deferred liabilities are recognized as revenue in the income statement. ### How do deferred liabilities affect cash flow initially? - [x] Increase cash flow - [ ] Decrease cash flow - [ ] No impact on cash flow - [ ] Only affect non-cash assets > **Explanation:** Deferred liabilities initially increase cash flow when the prepayments are received, although they represent future obligations. ### Which term is synonymous with deferred liability? - [ ] Accrued Liability - [x] Deferred Credit - [ ] Provision - [ ] Prepaid Expenses > **Explanation:** Deferred liability is also known as deferred credit, representing prepayments for future obligations. ### Why is it important for businesses to manage deferred liabilities effectively? - [ ] To evade taxes - [x] To ensure accurate financial reporting and future cash flow management - [ ] To inflate short-term revenue - [ ] To minimize operating expenses > **Explanation:** Effective management of deferred liabilities ensures accurate financial reporting and helps in forecasting future cash flows and obligations. ### Deferred liabilities can be a sign of what in terms of a company's operations? - [ ] Financial distress - [x] Future obligations and potential stability - [ ] Increased short-term revenue - [ ] Unsustainable growth > **Explanation:** Deferred liabilities indicate that a company has future obligations, which can also suggest stability if they are managed well and lead to future revenues. ### How could high levels of deferred liabilities be perceived by investors? - [x] As commitments for future performance - [ ] As immediate profit - [ ] As insufficient cash flow - [ ] As reduced revenue > **Explanation:** High levels of deferred liabilities can be perceived positively as they represent commitments to deliver products or services in the future, possibly indicating business growth and future revenue. ### What is a common feature of deferred liabilities and provisions? - [ ] Both are considered equity - [ ] Both are current assets - [x] Both involve future obligations - [ ] Both are immediate expenses > **Explanation:** Both deferred liabilities and provisions involve future obligations that a company needs to settle, even though their nature and timing might differ.

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