Definition of Deferred Expenses
Under the accrual basis of accounting, an expense is a cost that is used up, has expired, or is directly related to revenues reported on a company’s income statement. The objective of the income statement is to report how profitable a company was during a time interval (period of time), such as a year, quarter, month, 52 weeks, etc.
Costs that occurred but are not yet expensed on the income statement are typically referred to as deferred costs, deferred expenses, or prepaid expenses and are reported on the company’s balance sheet as current assets until they become an expense.
Examples of Deferred Expenses
Assume that a company pays $3,000 on December 30 to rent a warehouse for the upcoming three-month period of January 1 through March 31. Since none of the $3,000 expired or was used up in December, the entire $3,000 is deferred to the balance sheet account Prepaid Rent (or Prepaid Expenses,) which is a current asset.
During the three months of January 1 through March 31 (when the prepaid rent is expiring) the $3,000 prepayment must be moved from the balance sheet asset account to an income statement expense account. If the company issues monthly income statements, the company will prepare adjusting entries to move $1,000 each month from the Prepaid Rent account to Rent Expense.
When a retailer purchases goods to be resold, the cost of the goods purchased, but not yet sold, will be deferred to the current asset account Inventory. When goods are sold, the retailer moves the cost of those goods from Inventory to the income statement as the Cost of Goods Sold, which is an expense that is being matched with the related sales revenues.
