Deferred Income Query - The Book-keepers Forum (UK)

mj · Member

Deferred Income Query

AccountantsCircle · Senior Member

Hi Mary

Deferred/Unearned Income is when the work has been invoiced, or payment received (ie. cash Payment rather than invoice) and the work hasn't been completed.

To do with the 'Matching Principle', not when "a sole trader wants to defer income".

An example of this would be when payment in advance is collected, ie. before work commences. As the work hasn't been done in the period (month, quarter, year depending on management reporting - as well as the tax year) the portion of the revenue shown for the payment in advance is moved from the revenue account to the Deferred Income account (liability, as it may be refundable).

Then, as you say the entry is/can be reversed at the start of the next period in expectation the work will be done - and again considered at the end of that period for a new Deferred Income journal for that is still not earnt.

As for tax implications... people are tax on what they earn, profits etc. As the work hasn't been done, it hasn't been earnt and wouldn't yet be taxable.

mj · Member

Hi John

Many thanks for your clear and succinct reply, much appreciated!

So, if all the work (invoiced in advance) was expected to be paid for in the following months, it would be a simple case of reversing the journal entry at the start of the new tax year and this revenue would appear in the following year's accounts. Thus this revenue would appear on the P&L at the end of the next tax year, and the business owner would in effect be taxed for it then. Is this correct? And for intermediate management accounts during this tax year, any unpaid revenue could again be debited to the Deferred Income account?

Also, am I correct in thinking that Deferred Income is usually shown on a balance sheet together with accruals, rather than listed separately?

Again many thanks
Mary

AccountantsCircle · Senior Member

Hi Mary

It's not to do with when the work is paid. It's to do with when the work is actually performed.

Example...
A company is running a training session in April, but invoices attendees in advance in March. At the end of March those invoices result in this training revenue showing in March, but the training wasn't performed then... so that income needs to be moved out and into deferred income until the training is done.

The payment of the invoices is irrelevant. Some might pay in March, some might be in April... it doesn't affect the income. The only time receiving payments does affect it is when it's a cash receipt (ie. directly against revenue, not an invoice).

In this example, some attendees may postpone to a future training course... in say June. So even in April after the deferred income journal is reversed so the income is showing again, a further journal may be needed for those that didn't yet attend.

With management accounts, it's much like year end adjustments - journals such as WIP, accruals, prepayments, deferred income are all done for the reporting period (monthly, quarterly, annually etc).

Deferred income is a type of accrual but it's not usually shown with accruals in the Balance Sheet. Accruals and Prepayments are a type of current asset, whereas Deferred Income is a type of current liability (as this is possibly owed back to the customer until it has actually been earned).

Does that make more sense now?

mj · Member

Thanks John, the example really helped and I'm pretty sure I now understand the principle.

The real-life case I'm working with is a business who design websites. Their financial year ends in April and they invoice in advance. A batch of invoices was issued at the end of March '08, for projects not yet started. So what should have happened is that this income was debited to Deferred Income. Say for the sake of argument that they haven't done any intermediate management accounts - then at year-end this coming April, this income would be credited from the Deferred Income Account and back to the Revenue Account, and appear in the P&L at year-end 08/09. The only reason that it would not be moved back to the revenue account was if for example a client had asked for a project to be put on hold (in this case for a whole twelve months) and so work had not been performed.

Is that all correct?

Thanks too for explaining about deferred income on a balance sheet. Could deferred income be referred to as accruals, so long as it was within the liabilities section of the balance sheet?

Many thanks for taking the time to answer my question; I'm really grateful for your clear explantions.

AccountantsCircle · Senior Member

Hi Mary

What you're saying sounds right. Just to sum it up:

So if they invoice say 5 websites for £500 deposits (say 50% deposit and £1000 total each) on 31 Mar 08... it would show this in as £2500 in Website Design Income. Now because they haven't done that work yet you do credit the Deferred Income account and debit the WebDesign Income.

They then have a £2500 liability as it's not earnt, and the costs in earning that income have not yet been incurred (the other side of accrual accounting and the matching principle - so money earnt is matched against the costs of earning it in that same time period). They also have it showing in Debtors (unpaid invoices) or Cash at Bank - not so relevant as this doesn't affect it otherwise... but balances it as 'nil effect' on the Balance Sheet.

As they do earn it, it moves from that Deferred Income liability back to Website Design Income... and should then be seen in the P&L (for any time period) against web designer costs (staff), hosting costs, stock images etc - giving a true indication of the Revenue, Expenses, Profit/(Loss) in the period!

That's the purpose you are aiming for. How that's usually done with journals is by reversing it the following month (1 Apr 08) so it is recognised as income again.

Now although it's there, in a smooth operation people don't just look at P&L's anytime... so say on 14 Apr people wouldn't just look at the figures in the accounts software and think that's what it is... they wait for management accounts and use those for their management decisions and to know what is going on. So whenever people do need to know that information (monthly or quarterly is most common) the adjustments are done before reports are produced.

Say they do 25% of 3 of those websites, and 50% of the other 2 by the end of June when they have quarterly reports. As £2500 is in Website Design Income, this needs to be adjusted... just as it was on 31 Mar 08. So the revenue earnt is:

3 x £1000 x 25% + 2 x £1000 x 50% = £1750

So now just £750 of the £2500 is not yet earnt and needs to be journalled/credited back to the Deferred Income account for the same again next period.

Be it monthly, quarterly or annually - these are 'period adjustments' that are needed to get correct reporting - for management or statutory accounts.

I do think you are understanding it... but that might just help a little more.

With the terminology... to be honest I am not completely familiar with how people in the UK might refer to it (I am in Poland) but I've heard and do expect "accruals" to be used to mean all of these types of adjustments - for accrual accounting (so WIP, income and expense accruals, prepayments, and deferred income being the common ones).