What is a 'Deferred Charge'
A deferred charge is a long-term prepaid expense that is treated as an asset on a balance sheet and is carried forward until it is actually used. Deferred charges often stem from a business making a payment for a good or service that it has not yet received, such prepaying insurance premiums or rent.
BREAKING DOWN 'Deferred Charge'There are two systems of accounting: cash accounting and accrual accounting. Cash accounting records revenue and expenses as they are paid. Accrual accounting records revenue and expenses as they are incurred. When cash exchanges hands, it does not mean that the company records the cash as a revenue or expense. If the revenue or expense is not incurred in the period when the cash exchanges hands, it is booked as deferred revenue or deferred charges.
Deferred Charge Example
It is not unusual for a company to pay for a year of rent in advance to receive a discount. This advanced payment is recorded as a deferred charge on the balance sheet. Each month, the company recognizes a portion of the prepaid rent as an expense on the financial statements. The cash paid out for rent is a deferred charge. This is also considered to be an asset until it is fully expensed. Each month, another entry is made to move cash from the deferred charge on the balance statement to the rental expense on the income statement.
Deferred charges are actually a long-term version of prepaid expenses, referring to payments that the company has made prior to receiving the corresponding good or service. Prepaid expenses are a current account, whereas deferred charges are a non-current account.
Deferred Charge Vs. Deferred Revenue
Recording deferred charges ensures that a company's accounting practices are operating within generally accepted accounting principles (GAAP) by matching revenues with expenses each month. A company may capitalize the underwriting fees on a corporate bond issue as a deferred charge, subsequently amortizing the fees over the life of the bond issue.
Deferred revenue, on the other hand, refers to money that the company has received as payment before a product or service has been delivered. A prime example of a deferred revenue is the opposite side of the rental agreement. A tenant who pays for rent one year in advance may have a happy landlord, but that landlord must account for the rental revenue over the life of the rental agreement, not in one lump sum. As each month approaches, the company uses a portion of the funds from deferred revenue and recognizes this portion as revenue in the financial statements. As is the case with deferred charges, deferred revenue ensures that revenues for the month are matched with the expenses incurred for that month.