Definition
Deferred Revenue Expenditure refers to a business expenditure for which payment has been made, but benefits from it are expected to be received over multiple future accounting periods. This is not immediately recognized as an expense in the income statement and is treated as an asset on the balance sheet. It is proportionally allocated to expenses over the expected benefit periods.
Key Takeaways
- Deferred Revenue Expenditure refers to the business expense that is incurred but not entirely consumed in a specific accounting period. The benefits of these expenses are utilized over multiple accounting periods.
- This concept is essential in financial accounting as it differs from standard expenses. Unlike regular expenditure where the benefits are immediately consumed, deferred revenue expenditures are written off over a period where the benefits from them are expected to be generated.
- Understanding and accounting for Deferred Revenue Expenditure correctly is important as it impacts the financial statement of a company, particularly the balance sheet and income statement. It can influence the total assets, liabilities, revenue and overall financial status of a company.
Importance
Deferred Revenue Expenditure is an important finance term because it refers to significant expenses a company incurs that are expected to provide benefits beyond the current accounting period.
This concept is significant in financial planning and accounting as it allows businesses to spread out the cost of large expenditures over several periods.
This practice reflects more accurately the consumption of benefits of the expenditure in line with the matching principle in accounting.
Recognizing the complete expense in the period it was incurred can distort the financial statements and may not present an accurate portrayal of a company’s financial health and profitability.
Thus, understanding Deferred Revenue Expenditure is crucial for accurate financial reporting and making informed business decisions.
Explanation
Deferred Revenue Expenditure refers to a cost that is incurred by an organization but not instantly charged to expense. Rather, it is considered a type of expense that is to be written off or slowly charged to expense over a future period of time.
The purpose of this form of expenditure lies in its capacity to allow businesses to effectively manage costs that pertain to a significant amount of their revenue over an extended period–The rationale being that the benefit of these costs are likely to be reaped over multiple future periods rather than a single one. This sort of expenditure is typically substantial in nature, often linked to heavy advertising, promotional expenses, or significant startup costs.
The use of Deferred Revenue Expenditure is of strategic importance to businesses. It provides an opportunity to keep the balance sheet healthy by not immediately depleting the current year’s profits.
This prorating mechanism becomes particularly advantageous when the expenditure in question can generate economic benefits beyond the current year. Since such expenditures are not completely written off in the same year they are incurred, it lessens the burden on the profit and loss account for a single reporting period, making it a beneficial accounting practice for firms.
Examples of Deferred Revenue Expenditure
Advertising Campaigns: A company may pay for a large advertising campaign upfront, but the benefits of that campaign, in terms of generating customer awareness and attracting potential customers, are likely to be spread out over time. In this case, the cost of the campaign would be a deferred revenue expenditure as the company would gradually write off the cost over the period that the campaign is expected to benefit the company.
Research and Development Costs: A pharmaceutical company may invest a significant amount of money into the research and development of a new drug. It would take several years before the drug is ready for sale in the market. The company would treat the R&D investment as a deferred revenue expenditure, recognizing the cost over the period during which the drug is expected to generate revenue.
Leasehold Improvements: If a business leases a space and invests money in customizing or improving it to better suit the needs of the business, this could be considered a deferred revenue expenditure. The company expects to derive benefit from these improvements over the term of the lease, so it would spread the cost over that same period.
FAQs on Deferred Revenue Expenditure
1. What is Deferred Revenue Expenditure?
Deferred Revenue Expenditure is an expense that is revenue in nature but its benefit is likely to be derived over multiple future accounting periods. It is an expenditure the benefit of which will be realized over the period and not during the current period. Expenditure such as advertising costs are often treated as deferred revenue expenditures.
2. Does Deferred Revenue Expenditure appear on the Balance Sheet?
Yes, the unamortized part or the part not yet charged to the profit and loss account of deferred expenditure appears on the balance sheet under the head miscellaneous assets.
3. How is Deferred Revenue Expenditure treated in accounting?
In accounting, the Deferred Revenue Expenditure is initially recorded as an asset. As the benefits of the expenditure are realized, an equal portion is transferred to the Profit and Loss Account.
4. Can Deferred Revenue Expenditure be a source of finance?
No, Deferred Revenue Expenditure cannot be a source of finance because it is an already incurred expense that will simply benefit the company over multiple accounting periods.
5. Does Deferred Revenue Expenditure affect profit?
Yes, as the benefit of the deferred revenue expenditure is gained, an equal amount is transferred to the profit and loss account, thereby affecting both the revenue and profit of the company.
Related Entrepreneurship Terms
- Capital Expenditure: This refers to the money spent on acquiring or maintaining fixed assets.
- Revenue Expenditure: Regular and necessary costs incurred during business operations that will benefit only the current accounting period.
- Amortization: The process of gradually writing off the initial cost of an asset over a period of time.
- Depreciation: A method used to allocate a portion of the asset’s cost to periods in which the tangible assets helped generate revenues.
- Balance Sheet: A statement of the assets, liabilities, and capital of a business at a particular point in time.
Sources for More Information
- Investopedia: A comprehensive resource for everything related to finance and investing.
- Accounting Coach: Offering free and pro content about a variety of accounting topics.
- IAS Plus: A website that provides comprehensive information about international financial reporting in the public interest.
- CFO: This is an online news and feature publication that focuses on the latest issues in the financial world.
