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Lesson details
- Estimated study time
- 60 min
- Reading context
- Chapter 2
Deferral walkthroughUse this lesson when cash moves before Beacon earns revenue or uses the related resource.
Learning objectives (6)
This lesson follows two Alder transactions in which cash moves before the related expense or revenue. The first creates a prepaid asset. The second creates an unearned-revenue liability.
Record the cash transactions
On April 1, Alder pays $12,000 for insurance coverage from April 1 through March 31 of the following year. Assume coverage is provided evenly.
On November 1, a client pays Alder $6,000 for 6 months of design support from November 1 through April 30 of the following year. Assume service and revenue are provided and earned evenly throughout those six months.
The insurance payment records Alder's right to future coverage. The client payment records Alder's obligation to provide future service. Deferring the expense or revenue does not mean ignoring the cash transaction.
Update the balances at December 31
Nine months of insurance have expired by December 31. Alder has also provided 2 months of the 6-month support contract.
Cash does not appear in either adjustment because Alder recorded the payment and receipt on their transaction dates.
Reconcile recognized and remaining portions
| Cash-first amount | Recognized by December 31 | December 31 balance carried forward |
|---|---|---|
| $12,000 insurance payment | $9,000 Insurance Expense | $3,000 Prepaid Insurance asset |
| $6,000 client payment | $2,000 Service Revenue | $4,000 Unearned Revenue liability |
For insurance, $9,000 used plus $3,000 remaining equals $12,000. For the support contract, $2,000 earned plus $4,000 still unearned equals $6,000.
Compare deferrals with accruals
Accruals add a receivable or payable that the ledger does not yet include. Deferrals update an asset or liability recorded when cash moved earlier.
That contrast is a useful check, not a substitute for facts. An error can also leave totals unchanged. The preparer still needs the insurance contract, coverage dates, customer contract, milestone evidence, and review approval.
Read a rollforward without double counting
These are three parts of one reconciliation, not three amounts to add:
| Prepaid Insurance field | Amount | Meaning |
|---|---|---|
| Unadjusted balance | $12,000 debit | Starting month-end balance |
| Adjustment | $9,000 credit | Coverage used through December 31 |
| Adjusted balance | $3,000 debit | Coverage remaining after December 31 |
The valid bridge is $12,000 − $9,000 = $3,000. Adding the unadjusted balance, adjustment, and adjusted balance would count the same insurance more than once.
Check your understanding
A company pays $6,000 for 6 months of even insurance coverage and receives $8,000 for 4 equal service milestones. By month-end, 1 month and 1 milestone are complete. Assume no opening balances other than sufficient Cash for the payment, no other events, and that each completed and accepted milestone earns an equal share. Prepare the 2 cash-date entries and 2 adjustments. Then identify ending Prepaid Insurance, Unearned Revenue, Service Revenue, and Insurance Expense.
Check your entries and balances
At payment, debit Prepaid Insurance and credit Cash $6,000. At receipt, debit Cash and credit Unearned Revenue $8,000. Each milestone earns $2,000.
One month's insurance is $6,000 ÷ 6 = $1,000. Debit Insurance Expense and credit Prepaid Insurance $1,000, leaving $5,000 prepaid. Debit Unearned Revenue and credit Service Revenue $2,000, leaving a $6,000 liability. Ending Service Revenue is $2,000 and Insurance Expense is $1,000.
Use Chapter 2 practice: deferrals for additional questions.