What is deferred income?

We all know what income is, but why might you want to defer it?

Say you raise an invoice in January for 3 months worth of consulting fees. They cover the period from January to March.

This is money received for goods or services not yet delivered.

You could take 100% of the income in January but that would not really reflect the activity of your business if you deliver your consultancy throughout January, February and March – so we will defer the income out of January and spread it across February and March.

Also we need to consider the relationship with the customer. If they paid for 3 months service up front, and cancelled after 1 month or we were unable to deliver after 1 month, the customer may expect a refund of the amount not yet consumed.

  • The income is not truly ours, and should not be ‘committed’ to the profit and loss account until the service is delivered.
  • Any undelivered service is potentially still owed back to your customer  – and so should be reflected as a liability in our balance sheet.

Let’s look at the accounting entries:

  • Step 1. Post the sales invoice
  • Step 2. Work out how much do you need to allocate to each month and defer the income from the P&L to the Balance Sheet. In this example we will say that we have raised an invoice for £3000 that we want to spread evenly across February and March
  • Step 3. Write back the income related to February from the Balance Sheet to the P&L
  • Step 4. Write back the income related to March from the Balance Sheet to the P&L

In this example we are Vat registered so we need to consider the implications on the Vat account too.

Step 1

31-Jan- xx   Being the original invoice or cash receipt  of £3000. The sale would have been posted as an invoice through your sales ledger not as a journal. This is the double entry to help illustrate the point.

Transaction Debit Credit
Sales (P&L)  3000
VAT (BS) 600
Accruals (BS)  3600
Journal total 3600 3600

 

Step 2

31-Jan- xx   Being a journal to defer £2000 of income billed in January relating to February and March

Transaction Debit Credit
Sales (P&L)  2000
Deferred Income (BS)  2000
Journal total 2000 2000

February-xx

Now we want to write back February’s share of the deferred income so we will create another journal entry for our February write back.

Step 3

28-Feb- xx   Being the write back of February income

Transaction Debit Credit
Sales (P&L)  1000
Deferred Income (BS)  1000
Journal total 1000 1000

March-xx

Now we want to write back March’s share of the deferred income so we will create another journal entry for our March write back.

Step 4

31-Mar- xx   Being the write back of March income

Transaction Debit Credit
Sales (P&L)  1000
Deferred Income (BS)  1000
Journal total 1000 1000

In your profit and loss account – sales income for the quarter will have been:

  • £1000.00    January-xx    (The invoice of £3000 + VAT – less the deferred income of £2000)
  • £1000.00    February-xx  (The write back of February income from the balance sheet)
  • £1000.00    March-xx       (The write back of March income from the balance sheet)

In your balance sheet – the balance of your deferred income account would have been:

  • £2000.00      January-xx     (The total amount deferred from the income account in January)
  • £1000.00    February-xx      (£2000 carried over from January less £1000 written back to the P&L in February)
  • £0.00         March-xx            (£1000 carried over from January less £1000 written back to the P&L in March)

As you have now posted all of your income into the P&L – the balance of the deferred income account will now be nil.

 

   Top Tips

#
1 Don’t forget that income is deferred net of VAT. The VAT is payable by your client and owed to HMRC at the tax point date of the invoice.
2 Keep an eye on your deferred income account in the balance sheet, reconcile regularly to ensure that you don’t have carried deferred income in your balance sheet that should have been written back to your profit and loss.
3 One way of avoiding forgotten accruals – is to auto reverse them at the beginning of the next month forcing you to review the account each month end.

 

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