Deferred income: meaning and booking for companies

What is deferred income?

Deferred income, also known as deferred income liabilities, are liabilities in accounting that arise when a company receives payments for services or deliveries that will only be rendered in a future accounting period. These liabilities are important to ensure that income and expenses are recorded in the correct period. A common example from business practice is advance payments from customers for services that will only be provided in the next financial year. Suppose a consulting firm receives an advance payment in December for consulting services that will take place in the following year. This payment is recorded as deferred income because the associated service will only be rendered later.

Importance of deferred income

Using deferred income ensures that income and expenses appear in the correct accounting period, leading to a more accurate representation of a company’s financial position.

This accuracy is not only required by law, but is also indispensable for internal financial planning and analysis. Companies can better track their financial performance and make well-founded decisions when they know when and to what extent income and expenses arise. Without deferred income, revenue could be recognised in an earlier period before the associated services have been rendered, which would distort the financial position and could lead to poor decisions.

In addition, deferred income facilitates compliance with legal regulations and provides a transparent basis for external audits and reporting. Precise recording and allocation of income and expenses strengthens stakeholder confidence and preserves the financial integrity of the company.

Deferral entries

Deferral entries are an essential tool in accounting to ensure that expenses and income are recorded in the correct period. These entries are used to allocate income and expenses over time so that they appear in the period in which they actually arise. This is particularly important at the balance sheet date, as companies are required under the Swiss Code of Obligations (CO) to ensure accurate and period-appropriate financial reporting.

A common scenario for deferral entries is the accrual of operating costs such as rent or insurance, which are paid in advance but represent services for future periods. For example, if a company pays January’s rent in December, this amount must be deferred as a prepaid expense in order to be recorded in the correct financial year.

Prepaid expenses and deferred income are two sides of the same coin, but represent different economic events:

1. Deferred income:

   • Relates to income received in advance for which the service will not be rendered until a later period.
   • Example: A consulting fee paid in advance for services to be rendered next year.

2. Prepaid expenses:

   • Relate to expenses paid in advance for services or goods that will not be delivered until a future period.
   • Example: Advance payment of office rent or insurance premiums. These expenses are recorded as prepaid expenses because they provide a benefit for future periods.

Prepaid expenses are expenses paid in advance that have not yet been consumed. Deferred income is income received for which the corresponding service still has to be rendered. Both help to present economic performance by period and to depict a company’s financial position accurately.

Examples of deferred income

Deferred income occurs frequently in practice and can be found in various industries and companies. Here are some typical cases that show how deferred income is used in a business context:

1. Customer prepayments: Companies often receive prepayments for services or products that will only be rendered or delivered in a later period. These prepayments must be recorded as deferred income until the service has been fully rendered. An example of this is a consulting firm that receives an advance payment in December for consulting services to be provided in the following year.

2. Membership fees: Some organisations, such as professional associations or gyms, receive membership fees in advance for a specific period. Although the money has already been received, the service (membership benefits or access to facilities) is only rendered over the course of that period. These fees are recorded as deferred income until the service has been fully rendered.

3. Electricity, telephone and subscription costs: Companies often receive invoices for electricity, telephone or other subscriptions that relate to consumption or usage over a specific period. If these invoices have not yet been paid at the end of the year, but the services have already been used, they must be recorded as deferred income. This ensures that the expenses are recorded in the correct financial year.

Importance of deferred income for accounting

Deferred income plays an essential role in accounting, as it contributes to precise and period-based determination of profit and at the same time ensures compliance with legal requirements.

Period-based determination of profit

Period-based determination of profit is a fundamental principle of accounting that ensures income and expenses are recorded in the period in which they actually arise. Deferred income enables companies to allocate payments received in advance correctly and to recognise them as income only when the corresponding service has been rendered. This prevents income from being recognised prematurely and thus creating a distorted picture of the company’s financial position.

An example of this is an advance payment by a customer for a service to be rendered in the following year. By recording this payment as deferred income, it is ensured that the revenue is recognised in the financial year in which the service is actually rendered. This contributes to a realistic and accurate representation of the company’s financial results.

Legal requirements according to the Swiss Code of Obligations (CO)

According to Article 958b of the Swiss Code of Obligations (CO), all assets and liabilities of a company must be recorded on an accrual basis. This means that payments received for services or deliveries in future periods must be recorded as deferred income. Compliance with this regulation is not only a legal obligation, but also an essential component of a company’s financial integrity.

Proper accounting also requires that all relevant tax identification data, such as the tax identification number, be recorded and documented accurately. This facilitates traceability and ensures that the tax authorities receive all the necessary information. By correctly recording and allocating deferred income and the tax identification number, companies can ensure that their accounting complies with legal requirements and that their financial position is presented transparently and in a way that can be understood.

Furthermore, the reverse charge mechanism is another important aspect that companies must consider. Under the reverse charge mechanism, the tax liability shifts from the service provider to the recipient of the service. This is particularly relevant for cross-border services within the EU. Companies must ensure that they record the corresponding amounts correctly and forward the required information to the tax authorities.

By correctly recording and allocating deferred income, the tax identification number and the application of the reverse charge mechanism, companies can ensure that their accounting meets legal requirements and that the financial situation is presented in a transparent and comprehensible way.

In summary, deferred income is an indispensable tool in accounting for ensuring period-based determination of profit and meeting legal requirements. It helps to present a company’s financial situation precisely and transparently and thus creates a solid basis for well-founded business decisions.

Prepaid expenses and deferred income: comparison and examples

Prepaid expenses and deferred income are essential concepts in accounting that help record income and expenses on an accrual basis. Although they serve similar purposes, there are important differences between them. These differences and some examples are explained in more detail below.

Examples of prepaid expenses

Prepaid expenses relate to expenses that have been paid in advance for services or goods that will not be received until a future period. A typical example is prepaid rent:

• Prepaid rent: If a company pays the rent for its office space in advance, for example in December for the month of January, this amount is recorded as a prepaid expense. This recording ensures that the expenses are recognised in the correct financial year, in which the service (the use of the office space) actually takes place. This enables accurate allocation of costs and contributes to precise determination of profit.

Differences and similarities

• Prepaid expenses relate to expenses paid in advance, the benefit of which does not arise until a later period. Examples include prepaid rent or insurance premiums.

• Deferred income relates to income received in advance, where the corresponding services are not rendered until a later period. Examples include customer prepayments for services to be rendered in the following year.

Similarities:

• Both concepts serve period-based determination of profit and are crucial for precise and transparent bookkeeping.
• They help to present a company’s financial results correctly by ensuring that income and expenses are recorded in the correct period.

By precisely recording and distinguishing prepaid expenses and deferred income, companies can present their financial position accurately and ensure that all business transactions are recorded on an accrual basis. This is crucial for complying with legal regulations and preparing reliable financial statements.

Tips for correctly recording deferred income

Step-by-step guide to posting

Correctly recording deferred income is crucial to ensure accurate and period-based financial reporting. Here is a step-by-step guide:

1. Record incoming payment:

   • When your company receives an advance payment, first post the amount to a deferral account.
   • Example: An advance payment of CHF 12,000 for a one-year service contract starting on 1 December.
     • Debit: Bank account (CHF 12,000)
     • Credit: Deferred income (CHF 12,000)

2. Accrual at year-end:

   • At the end of the financial year, the part of the advance payment that qualifies as income in the current year must be accrued.
   • For an advance payment of CHF 12,000 and monthly service provision of CHF 1,000:
     • Debit: Deferred income (CHF 1,000)
     • Credit: Sales revenue (CHF 1,000)

3. Ongoing postings in the new year:

   • In the new financial year, the remaining amount is accrued monthly on a rolling basis until the entire advance payment has been recognised.
   • Example of the posting in January of the new year:
     • Debit: Deferred income (CHF 1,000)
     • Credit: Sales revenue (CHF 1,000)

Common mistakes and how to avoid them

There are some common mistakes in recording deferred income that can be avoided:

• Incomplete accruals: Not all advance payments or accrued liabilities are recorded. Solution: Create a checklist of all regular advance payments and check at year-end whether all relevant items have been recorded.

• Incorrect period allocation: Income and expenses are not recorded in the correct period. Solution: Regularly review your postings and use accounting software that automatically calculates accruals.

• Missing reversals: Deferral items are not reversed in the new year, leading to distortions. Solution: Set reminders in your accounting software to ensure that reversals are made on time. Regularly review the accounts for prepaid expenses and deferred income to ensure they are reset to zero at the beginning of the new year.

• Incorrect VAT postings: VAT is incorrectly recorded in deferral entries. Solution: Post deferral items without VAT codes and ensure that your accounting software is configured accordingly.

By carefully recording and accruing deferred income and avoiding common mistakes, your company can ensure precise and transparent financial reporting that meets legal requirements and forms the basis for well-founded business decisions.