Deferral-type adjusting entry definition

What is a Deferral-Type Adjusting Entry?

A deferral-type adjusting entry is an accounting entry that shifts some portion of a recognized amount into a future period. This journal entry may be used to defer the recognition of revenue or an expense. There are two situations in which a deferral-type adjusting entry may be used, which are noted below.

Prepaid Expenses . A prepaid expense is a payment made for which some or all of the expense recognition is deferred. For example, a business purchases liability insurance for $24,000 at the beginning of the year, and uses a deferral-type entry to defer $22,000 of this amount to the next month. In each subsequent month, another $2,000 of this deferral is charged to expense, until the total deferral is eliminated at the end of the year.
Unearned revenues . Unearned revenue is a payment received from a customer, for which the seller has not yet delivered the related goods or services. For example, a snow plowing company receives a $4,000 plowing fee from a customer at the beginning of the winter season, and then recognizes $1,000 of it as revenue in each subsequent month, as it provides services to the customer.

Characteristics of a Deferral-Type Adjusting Entry

The key characteristics of a deferral-type adjusting entry are as follows:

Postpones recognition . Deferral entries delay the recognition of revenues or expenses until they are earned or incurred.
Linked to prepaid or unearned items . Deferral entries are commonly associated with prepaid expenses or unearned revenue.
Adjustment at period-end . Adjustments are made at the end of the accounting period to transfer the appropriate portion of prepaid expenses to expense accounts, or to recognize earned revenues from unearned revenue accounts.
Dual-account impact . Deferral-type adjusting entries always involve one balance sheet account and one income statement account.
Temporary nature . Deferral-type entries are temporary and occur only at the reporting period's close.
Ensures accurate financial reporting . Deferral-type entries ensure that revenues and expenses are reported in the correct accounting periods.
Non-cash adjustments . Deferral-type entries do not involve actual cash flows during the adjustment process. They only involve the reclassification of amounts already recorded.

When to Use a Deferral-Type Adjusting Entry

A deferral-type adjusting entry is only used in accrual basis accounting , and usually only during the closing process, in preparation for the release of financial statements .