Deferral accounting is an area which is frequently misunderstood and in most cases an area of several manual errors 🤯. The latter is what we need to focus on, to move away from manual entries to automated ones but before that we need to understand the underlying concept.
Let us start off by defining a Deferred expense, which is the delay in the recognition of an expense until the expense in question is actually consumed or the service enjoyed. One very common such expense would be rent where we tend to pay in advance for a number of months and thus the accountant has to defer the payment over the said months. In the period between the payment and the recognition of the expense, the company would have recognised the prepaid amount as a current asset.
The concept is very straightforward and likewise the double entry. So where does the complexity lie? Whilst the concept are very straightforward yet the number of entries may potentially be quite substantial, potentially giving rise to inputting errors which may be material.
Let us take in example the prepaid rent. In our case scenario the company has paid €12,000 for the rent covering the period January to June. The payment has taken place in January.
Double Entry for January
Debit Rent Expense A/C (Income Statement)
Debit Prepaid Rent (Balance Sheet)
Credit Bank
Double Entry for February to June periods
Debit Rent Expense A/C (Income Statement)
Credit Prepaid Rent (Balance Sheet)
This means that one single transaction would have give rise to no less than at least 13 lines of double entries. Needless to say that this can be way more complex especially when attaching a figure to each entry.
Automation
The concept is very straightforward however the monthly entries are very cumbersome and at time confusing. Besides dealing with one prepaid costs is one thing, but dealing with hundreds of them is a very different story. Some ERP systems, one of them being Dynamics 365 Business Central, would allow the user to define all the above from the very start by defining:
the total amount paid
the total amount which is to be deferred
the Income Statement account where the expense recognition is to occur
the Balance Sheet account where the asset is to be recorded/depleted
the period over which the deferred amount is to be recognised
the criteria by which the deferred amount is to be spread out (eg fixed monthly or fixed daily or manual calculation)
Choosing the right ERP system is key to facilitate such circumsances which may not be complex by nature but the volume will inherently add to the complexity leading to higher risk of errors and a resource-hungry process.
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