Deferred asset definition
/What is a Deferred Asset?
A deferred asset is an expenditure that is made in advance and has not yet been consumed. It arises from one of the following two situations:
Short consumption period. Where the expenditure is made in advance, and the item purchased is expected to be consumed within a few months. This deferred asset is recorded as a prepaid expense, so it initially appears in the balance sheet as a current asset.
Long consumption period. Where the expenditure is made in advance, and the item purchased is not expected to be fully consumed until a large number of reporting periods have passed. In this case, the deferred asset is more likely to be recorded as a long-term asset in the balance sheet.
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Accounting for Deferred Assets
The reason for treating expenditures as deferred assets is that they would otherwise be charged to expense before the related benefits had been consumed, resulting in inordinately high expense recognition in earlier reporting periods, and excessively low expense recognition in later periods.
The deferred asset concept is not applied when a business uses the cash basis of accounting, since expenditures are recorded as expenses as soon as they are paid for under that method. Thus, these items would be charged to expense at once under the cash basis of accounting.
It is easy to forget about deferred asset items that are sitting on the balance sheet, which means that there tends to be a large write-off of these items at year end, when accounts are being examined by the auditors. To avoid this potentially large write-off, track all deferred asset items on a spreadsheet, reconcile the amounts on the spreadsheet to the account balance listed in the general ledger at the end of each reporting period, and adjust the account balance (usually with a periodic charge to expense) as necessary.
Deferred Asset Best Practices
There are several accounting best practices related to deferred assets. They are as follows:
Avoid initial recordation. To avoid the labor associated with tracking deferred assets, consider adopting an accounting policy under which expenditures falling beneath a minimum amount are automatically charged to expense.
Require a periodic review. There should be a review of all deferred assets as part of the closing process. This forces the accounting staff to examine these assets and decide whether they should be retained or written off.
Types of Deferred Assets
The following are all assets that may be classified as deferred assets:
Prepaid rent. A company pays rent for office space six months in advance. Until the rent is used up month by month, the payment is recorded as a deferred asset on the balance sheet.
Prepaid insurance. Insurance premiums paid ahead for coverage over several months or a year are considered deferred assets. The cost is gradually expensed over the period the insurance covers.
Prepaid advertising. If a business pays for an advertising campaign in advance, the amount is recorded as a deferred asset. The expense is recognized as the ads are published or aired over time.
Prepaid maintenance contracts. A company might pay in advance for maintenance services on equipment or software. This upfront payment is recorded as a deferred asset and expensed as the service is provided.
Leasehold improvements. If a tenant pays for property upgrades that benefit future periods, the cost is deferred and amortized over the lease term. This spreads the cost in line with the economic benefit received.
Prepaid subscriptions. Paying upfront for magazine or software subscriptions that span multiple periods is a deferred asset. The cost is recognized as an expense each month the subscription is active.
Deferred loan fees. When a business pays fees upfront to secure a loan, the costs are deferred. These are amortized over the life of the loan as interest expense.
Prepaid consulting services. A company may pay a consultant in advance for services to be rendered over several months. The payment is recorded as a deferred asset and expensed as the services are performed.
Deferred tax assets. These arise when a company overpays taxes or has deductible temporary differences. The benefit is recognized in future periods when it can reduce taxable income.
Prepaid utilities. If utility bills are paid in advance, the amounts are treated as deferred assets. They are expensed in the month the utility service is actually used.