What is a Deferred Credit?

A deferred credit is cash received that is not initially reported as income, because it has not yet been earned. In most cases, a deferred credit is caused by the receipt of a customer advance. This is a situation where a customer pays the seller before the seller has provided it with an offsetting amount of services or merchandise.

Accounting for a Deferred Credit

Since the seller has not yet earned the corresponding amount of revenue, it should instead record the payment as a current liability. Once the seller has provided services or shipped merchandise, it can debit the liability account to eliminate the liability, and credit the revenue account to recognize revenue. At this point, recognition of the credit is no longer deferred.

If the seller is unable to provide the services or merchandise for which the customer advance was paid, the correct transaction (subject to the terms of the contract) is to pay the customer back, which results in a debit to the liability account and a credit to the cash account. This situation arises when a prepaid customer order is placed on backorder status, and the backordered item cannot subsequently be filled.

Presentation of a Deferred Credit

Deferred credits are usually presented on a reporting entity’s balance sheet as an unearned customer advance. If this amount is expected to be earned within one year, then it is classified as a short-term liability. Otherwise, it is classified as a long-term liability (which is a relatively rare occurrence). An example of the presentation for a short-term liability appears in the following exhibit.