Running a business can be expensive. Rent payments, utilities, taxes, and equipment can all come with a hefty price tag. And if you have employees, you also have to throw in the payroll costs. So to save some money now and pay later, you may consider a deferred payment. But, what is deferred payment, and when can you use it?
What is deferred payment?
What does deferred payment mean? Deferring a payment is when you purchase something and pay for it later. Deferred payments are also known as payment deferrals, accused revenue, or a “promise to pay.”
How does a deferred payment work? With deferred payments, vendors and customers typically come to an agreement (i.e., a deferred payment agreement) that lets the customer take possession of an item now and pay the cost at a later date.
Depending on the agreement, deferred payments may come with interest, too (and we’ll get to that later).
Payment deferrals on invoices
So, what does payment deferred mean on an invoice? If you see a note on an invoice that says “Payment Deferred,” it means that the customer is sending the payment in the future. Regardless of if you are the one sending or receiving the invoice, a note that the payment is due at a later time benefits both parties.
If you are the vendor deferring payment, you can add an indication that you deferred the customer’s payment, but it’s not necessary. Most customers assume that receiving an invoice means you deferred their payments until the product or service is complete.
You may also see a note on an invoice you receive with payment details and recognition of a payment deferral.
Deferred payment examples
Again, there are different ways to have deferred payments. You could defer payments you owe to vendors or offer a deferred payment plan to your customers. Take a look at some deferred payment examples.
You own a construction company and are building a new retail space for Company A. So, you need building materials such as lumber, nails, tile, paint, etc. The total cost of the materials is $30,000. But, you do not have $30,000 on hand to pay for the materials yet.
You purchase all of your materials from Company B and work out a deal where Company B lets you take the materials now and pay for them later. Based on your agreement with Company B, you pay for the materials in installments of $10,000. Your first payment is due four weeks after you receive the materials rather than on the purchase date.
Because Company B lets you take the supplies now with the agreement to pay for the materials later, you have deferred payments.
Let’s say you own a company that sells electronics. A longtime customer needs 10 new laptop computers for his office building, totaling $5,000. Your shop offers financing for large purchases, but you require a 10% down payment.
The customer pays you $500 now ($5,000 X 10%), and you set up an agreement with the customer for them to pay off the remaining balance within 12 months. The customer’s monthly payments are deferred.
Loans vs. deferred payments
A deferred payment plan is not a loan. However, you can have payment deferrals for your loans. Confusing, right?
Deferred payments are interest-free payment options that allow you or your customers to buy now and pay later. So, someone who defers a $500 payment only pays $500 when the payment is due.
With loans, customers generally pay interest on top of their standard repayment (i.e., the principal). Lenders may also add finance charges. So, a $500 loan could end up costing a borrower more than $500 when it comes time to repay the loan.
For example, your loan is $1,000 with 0% interest, but there is a finance charge of $50. So, your total deferred payments equal $1,050 ($1,000 + $50) instead of $1,000.
Loan payment deferrals
Sometimes, lenders allow you to defer loan repayments for specific reasons, such as COVID-19 or short-term hardships. You may still accrue interest on your loans even if you defer your payments, driving up the total cost of the loan.
Check with your financial institution or lender if you need to defer loan payments for any reason.
How to account for deferred payments
For sellers, deferred payments are accrued revenue, which is money not yet received for goods or services that were already delivered to the customer. In double-entry bookkeeping, you must record the transaction when you accrue the revenue and when you receive it.
Before the company pays, debit your Accrued Revenue account and credit your Revenue account.
After the customer pays, make an adjusting journal entry. Debit your Revenue account and credit your Accrued Revenue account. Here’s what the journal entry looks like:
Deferred revenue vs. deferred expenses
A deferred payment is different from deferred revenue and deferred expenses. Take a look at how they differ below.
Deferred revenue is the opposite of deferred payments. With deferred revenue, you pay upfront for the goods or services rather than after delivery.
Deferred revenue is a liability in your books because it is for goods or services you still owe to your customers. Record deferred revenue on your balance sheet as an asset until you incur the expense. After you incur the expense, decrease the asset and record the expense on the income statement.
For example, say a customer needs 50 new laptop computers for their business. The customer selects a computer you do not have in stock. You tell your customer that you can order the computers and deliver them once they are in stock. The customer pays the total cost at the time of the pre-order. You now have deferred revenue.
Record deferred revenue in your books before you perform services or deliver goods. Debit your Cash account because the funds to your business increased, and credit your Deferred Revenue account because the amount of deferred revenue is also increasing.
After you perform the service or deliver the goods, record another journal entry. Debit (decrease) your Deferred Revenue account and credit (increase) your Revenue account.
Deferred expenses are items you prepay in advance. This can include paying your rent or mortgage before your payments are due. Do not report deferred expenses on your income statement.
Record the deferred expenses as assets on your balance sheet when you incur the expenses.
For example, you prepay your mortgage. Use your Prepaid Mortgage account and your Cash account to record the transaction. Here is how you report the original deferred expense:
As you incur expenses, decrease your Prepaid Mortgage account and increase your Mortgage Expense account.
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