What are “The Deferreds?” It sounds like a movie title!
By definition, the word “defer” means “to put off or postpone.” How exactly does this apply to the accounting for your business? Well, “The Deferreds” refer to the deferred assets and liabilities you may need to record under GAAP.
There are several common categories of deferred liabilities:
In this segment, we explore these various types of deferred liabilities and what part they play in the accounting for your business.
Deferred revenue—sometimes referred to as unearned revenue or unearned income—is pretty much exactly what it says. It looks at the money you received for business operations but have not earned (At least not yet). These include payments that made to you by your customers for a future service or good that you’ll provide to them.
Continuing with our long-running bar example (see previous installments!), let’s assume that, in the back of your bar, you have a room for catering small events. A nearby business needs to host quarterly meetings over the next two years, and they would like to hold those meetings in your space. To ensure the room is always available for them, they would like to reserve it and pay up front.
You agree on a per meeting price —$500 each—and they write you a check for $4,000 and give you the requested dates. Well, you just made a sale of $4,000, right? Not so fast.
Remember when we discussed the “matching principle” way back in our second installment “GAAP” (Scary Word No. 1). You must match expenses with the revenue that helped generate them. Since your businesses has not yet incurred the expenses for your customer’s quarterly meetings and you have not yet earned the revenue, the amount received for this agreement must be listed as deferred revenue.
This deferred revenue goes on your balance sheet instead of your statement of operations. Deferred revenue is a liability because you are now obligated to perform this service and provide the meeting space. You have the cash, but you still must provide the use of the room to your customer. As the meetings occur, you will record the revenue earned ($500 per meeting) and reduce your deferred revenue accordingly.
Deferred rent describes the difference between your monthly rent payment and your actual rent expense.
Wait. Why would any difference exist, you ask?
Well, this occurs when the lease for your premises calls for escalated rent payments or offers a period of free rent. For example, the lease on our hypothetical bar is a five-year lease calling for total payments of $294,000. Per the lease agreement:
Under GAAP, you must recognize rent expense on a straight-line basis over the term of the lease. If the lease costs $294,000, then the monthly rent expense is $4,900. This is your actual monthly rent expense!
So, how exactly do we book this entry? Well, every month you would recognize the rent expense for $4,900 and credit deferred rent on your balance sheet. When you make the monthly payments (as per the lease agreement), you must debit deferred rent and subsequently credit cash. The difference makes up the “deferred” portion of the rent. You continue this entry and, by the time the lease is over, your deferred rent on the balance sheet equals zero.
Deferred compensation exists whenever a portion of an employee’s earnings are paid out in a year other than the year in which the employee earned them. There are several types of deferred compensation plans, including post-employment retirement plans or stock appreciation rights.
Typically, such arrangements are part of an agreement set up by an employer for key employees. While there are several steps that must be taken to enter and maintain this type of arrangement, the accounting treatment results in a deferred liability on your books. You record the amount of the deferred compensation on your balance sheet, and it remains there until you pay it out.
It sounds great, but don’t misunderstand: This does not mean you get to postpone payment on your taxes. (Wishful thinking!)
Ok, so what does “deferred tax” mean, then? Well, let us explain:
You keep your books using GAAP. However, Uncle Sam has his set of rules and, when it comes to reporting your income to the IRS, he wants you to do things his way. This creates differences between your book income and your tax income, and some of these differences generate a deferred tax liability or a deferred tax asset.
One common example relates to the depreciation deduction since the IRS allows for accelerated depreciation and other special depreciation. (We discussed this in the installment Scary Word No. 6 – PPE.) This temporary difference means paying fewer taxes in the present. It does not mean you won’t pay the taxes eventually; it means that you will pay them during a future period.
In this particular case, this temporary difference becomes your deferred tax liability. However, you can also have a deferred tax asset, in which case you pay the taxes now, but you receive a deduction in the future—an example of this would be deferred compensation. For tax purposes, deferred compensation can only be taken as a deduction when the employer pays the compensation. You won’t receive the benefit of your deduction when you book the deferred compensation; you get the benefit of the deduction when you pay the compensation.
There you have it: a little bit more insight on the accounting for your business. We hope you enjoyed “The Deferreds.”
Yesenia Cardona, William Ryan and Charle Saydek are managers in EisnerAmpers's Private Business Services Group. EisnerAmper LLP is one of the nation's leading audit, tax and business advisory firms.
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