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In accounting, a deferral recognizes income or expenses precisely when the cash transaction occurs.
Answer: False
Explanation: The fundamental definition of a deferral in accounting is that it recognizes income or expenses at a future date, distinct from the timing of the cash transaction. This contrasts with recognizing them precisely when cash changes hands.
The revenue recognition principle requires that revenue is recorded only when cash is received, regardless of when it is earned.
Answer: False
Explanation: The revenue recognition principle mandates that revenue is recorded when it is earned, not solely upon the receipt of cash. This principle is central to accrual accounting and the proper treatment of deferrals.
Accrual accounting requires revenue to be recognized only when cash is received, leading to the use of deferred revenue.
Answer: False
Explanation: Accrual accounting requires revenue recognition when earned, not necessarily when cash is received. Deferred revenue arises precisely because cash is received before revenue is earned.
The matching principle ensures that expenses are recorded in the period cash is paid, regardless of when benefits are received.
Answer: False
Explanation: The matching principle ensures that expenses are recorded in the same period as the revenues they help generate, regardless of when cash is paid. This often necessitates deferrals.
The concept of a going concern is irrelevant to the practice of deferrals.
Answer: False
Explanation: The going concern assumption is fundamental to deferrals, as it justifies spreading costs and revenues over multiple periods, assuming the entity will continue to operate.
Double-entry bookkeeping requires that deferrals are recorded with only one entry, either debiting an asset or crediting a liability.
Answer: False
Explanation: Double-entry bookkeeping requires two entries for every transaction. The initial recording of a deferred expense, for example, involves a debit to the asset account and a credit to cash.
Which accounting principle guides the matching of costs with the revenues they help generate, influencing the use of deferrals?
Answer: The matching principle
Explanation: The matching principle is the core accounting concept that dictates expenses should be recognized in the same period as the revenues they help generate, thereby influencing the necessity and application of deferrals.
How does double-entry bookkeeping handle the initial recording of a deferred expense?
Answer: A debit to deferred expense (asset) and a credit to cash.
Explanation: The initial recording of a deferred expense involves debiting the deferred expense asset account and crediting the cash account, adhering to the principles of double-entry bookkeeping.
What is the primary purpose of using deferrals in accounting?
Answer: To align financial reporting with the periods revenue is earned and expenses are incurred.
Explanation: The primary purpose of deferrals is to ensure that financial reporting accurately reflects the economic substance of transactions by matching revenues with the periods they are earned and expenses with the periods they are incurred.
Deferred expenses represent costs paid in advance for future benefits.
Answer: True
Explanation: This statement accurately defines deferred expenses, which are costs disbursed in advance and represent an asset due to the future economic benefits they are expected to provide.
A deferred expense is also known as a prepayment or prepaid expense.
Answer: True
Explanation: This statement accurately reflects the common terminology used in accounting, where deferred expenses are frequently referred to as prepayments or prepaid expenses.
An annual insurance payment is fully expensed in the month it is paid.
Answer: False
Explanation: Under accrual accounting, an annual insurance payment is treated as a prepaid expense (asset) and is expensed systematically over the coverage period, not entirely in the month of payment.
Deferred expenses are recognized as revenue on the income statement when paid.
Answer: False
Explanation: Deferred expenses are recognized as expenses on the income statement when the related benefits are received or consumed, not when they are paid. They represent future benefits, not revenue.
Prepayments are distinct from deferred expenses and represent cash received in advance.
Answer: False
Explanation: Prepayments are essentially synonymous with deferred expenses; they represent cash paid in advance for future benefits, not cash received in advance.
The purpose of recording deferred expenses is to understate current assets.
Answer: False
Explanation: The purpose of recording deferred expenses is to accurately reflect future economic benefits as assets, thereby correctly stating current and future assets, not to understate them.
What is the primary characteristic of a deferred expense?
Answer: It is cash paid in advance for goods or services to be received in the future.
Explanation: The primary characteristic of a deferred expense is that it represents cash paid in advance for goods or services that will be consumed or received in a future accounting period, thus constituting an asset.
What is another common term for a deferred expense?
Answer: Prepayment
Explanation: A deferred expense is commonly referred to as a prepayment or prepaid expense, signifying a cost paid in advance for future benefits.
If a company pays for a 12-month service contract on January 1st, how is the portion covering February recognized?
Answer: As a reduction of the deferred expense asset in February
Explanation: As February commences, the portion of the service contract applicable to that month is recognized as an expense, reducing the initial deferred expense (asset) balance.
When an annual insurance premium is paid, what is the accounting treatment for the portion covering future months?
Answer: Recorded as a prepaid expense (asset)
Explanation: The portion of an annual insurance premium covering future months is recorded as a prepaid expense, an asset on the balance sheet, to be recognized as an expense over the coverage period.
The accounting treatment for cash paid for goods not yet received by the end of an accounting period is:
Answer: Record as a prepayment (deferred expense).
Explanation: Cash paid for goods not yet received is recorded as a prepayment (deferred expense), an asset, to reflect the future economic benefit and adhere to the matching principle.
Deferred charges are costs expected to provide a benefit within one year.
Answer: False
Explanation: Deferred charges are typically costs expected to provide benefits over periods longer than one year, often five years or more, distinguishing them from shorter-term prepaid expenses.
Startup costs and significant advertising campaigns are examples of deferred charges.
Answer: True
Explanation: Expenditures such as startup costs and major advertising campaigns, which are expected to yield benefits over an extended period, are appropriately classified as deferred charges.
Prepaid expenses like insurance are typically recognized over longer durations than deferred charges.
Answer: False
Explanation: Conversely, deferred charges typically cover longer durations (often five years or more) than prepaid expenses, which are generally recognized over shorter periods.
Financial ratios often include deferred charges in total asset calculations to provide a more conservative view.
Answer: False
Explanation: Analysts often exclude deferred charges from total asset calculations when computing financial ratios to present a more conservative financial position, as these assets lack physical substance and do not directly generate cash.
Startup activities, when capitalized, are treated as deferred charges.
Answer: True
Explanation: Costs associated with startup activities that are capitalized are indeed treated as deferred charges, representing expenditures expected to provide future benefits.
Amortization is the process of expensing a deferred charge over the period it benefits.
Answer: True
Explanation: Amortization is indeed the systematic process of expensing the cost of a deferred charge over its useful life or the period it provides economic benefits.
Which of the following is an example of a cost typically classified as a deferred charge?
Answer: Costs associated with startup activities
Explanation: Costs associated with startup activities are typically capitalized and treated as deferred charges, as they are expected to provide benefits over an extended period.
How do deferred charges generally differ from prepaid expenses in terms of duration?
Answer: Deferred charges typically cover longer periods (5+ years) than prepaid expenses.
Explanation: The primary distinction lies in their duration; deferred charges generally benefit the entity for periods exceeding five years, whereas prepaid expenses typically cover shorter durations.
Why might analysts exclude deferred charges when calculating financial ratios?
Answer: Because they lack physical substance and don't directly generate cash or reduce liabilities.
Explanation: Deferred charges are often excluded from ratio analysis because their intangible nature and indirect cash generation potential can make them less relevant for assessing immediate liquidity or operational efficiency compared to tangible assets.
The amortization of a deferred charge means:
Answer: The cost is gradually expensed over its benefit period.
Explanation: Amortization of a deferred charge involves systematically recognizing its cost as an expense over the period it provides economic benefits, thereby reducing the asset's book value.
What does the term 'startup activities' refer to in the context of deferred charges?
Answer: Costs related to establishing a new business or venture.
Explanation: In accounting, 'startup activities' refers to the expenditures incurred in the process of establishing a new business or venture, which may be capitalized as deferred charges.
Which of the following best describes the nature of deferred charges on the balance sheet?
Answer: Long-term assets representing future benefits from past expenditures.
Explanation: Deferred charges are best described as long-term assets that represent the future economic benefits derived from expenditures made in prior periods.
Which of the following best distinguishes deferred charges from prepaid expenses?
Answer: Deferred charges typically benefit the company for longer periods (5+ years) than prepaid expenses.
Explanation: The primary distinction is temporal: deferred charges generally represent benefits extending beyond five years, whereas prepaid expenses typically cover shorter durations.
When a portion of a prepaid service contract is used each month, it is recognized as deferred revenue.
Answer: False
Explanation: When a portion of a prepaid service contract is used, it is recognized as an expense, reducing the deferred expense (asset) account, not as deferred revenue. Deferred revenue relates to payments received for services not yet rendered.
Cash paid for services not yet received by year-end is recorded as deferred revenue.
Answer: False
Explanation: Cash paid for services not yet received is recorded as a deferred expense (prepayment), an asset. Deferred revenue represents cash received for services not yet rendered, a liability.
Deferred revenue signifies a company's obligation to deliver future goods or services for which payment has already been received.
Answer: True
Explanation: This statement accurately defines deferred revenue as a liability representing an obligation to provide future goods or services for which payment has been received in advance.
Deferred revenue is recognized as revenue immediately upon receipt of cash.
Answer: False
Explanation: Under accrual accounting, deferred revenue is recognized as revenue only when it is earned, typically upon the delivery of goods or performance of services, not immediately upon cash receipt.
An upfront annual software license fee received on January 1 is entirely recognized as revenue by May 31 if the fiscal year ends then.
Answer: False
Explanation: Only the portion of the annual fee earned within the fiscal year (January 1 to May 31, i.e., 5/12ths) is recognized as revenue. The remainder is deferred revenue (liability).
Deferred revenue represents an obligation to pay suppliers for services already received.
Answer: False
Explanation: Deferred revenue represents an obligation to deliver goods or services to a customer for which payment has already been received, not an obligation to pay suppliers.
What is deferred revenue also referred to as?
Answer: Unearned revenue
Explanation: Deferred revenue is commonly referred to as unearned revenue, signifying revenue that has been received but not yet earned through the provision of goods or services.
Deferred revenue represents an obligation to:
Answer: Deliver future goods or services
Explanation: Deferred revenue signifies a company's liability to deliver future goods or services to a customer for which payment has already been received.
Under accrual accounting, when is deferred revenue recognized as actual revenue?
Answer: As the goods are delivered or services are performed.
Explanation: Deferred revenue is recognized as actual revenue under accrual accounting principles as the underlying obligation is fulfilled, meaning as goods are delivered or services are performed.
A company receives an annual subscription fee on March 1st. If its fiscal year ends December 31st, how much is recognized as revenue in the current year?
Answer: 10/12 of the annual fee
Explanation: From March 1st to December 31st is 10 months. Therefore, 10/12 of the annual subscription fee is recognized as revenue in the current year, with the remaining 2/12 recognized in the next fiscal year.
How does accrual accounting handle cash received for services to be performed next year?
Answer: Records it as deferred revenue (a liability).
Explanation: Under accrual accounting, cash received for services to be performed in a future period is recorded as deferred revenue, a liability, until the services are rendered and the revenue is earned.
The recognition of revenue from deferred revenue occurs when:
Answer: The obligation to the customer is fulfilled.
Explanation: Revenue from deferred revenue is recognized when the company fulfills its obligation to the customer by delivering the goods or performing the services.
If a company receives payment for a 3-year service contract, the portion covering the second and third years is initially recorded as:
Answer: Deferred Revenue
Explanation: The portion of the payment covering the second and third years of a 3-year service contract is initially recorded as deferred revenue (a liability) because the revenue has not yet been earned.
Deferrals are always recorded as liabilities on a company's balance sheet.
Answer: False
Explanation: Deferrals can be recorded as either assets (deferred expenses) or liabilities (deferred revenue) on a company's balance sheet, depending on whether they represent a future economic benefit or an obligation.
Deferred charges are typically presented as current assets on the balance sheet.
Answer: False
Explanation: Deferred charges are typically classified as non-current assets on the balance sheet due to their long-term nature and the extended period over which their benefits are realized.
Deferred revenue is classified as an asset because it represents future economic benefit.
Answer: False
Explanation: Deferred revenue is classified as a liability because it represents an obligation to deliver goods or services, not a future economic benefit to the company.
Deferred expenses are classified as liabilities because they represent obligations to suppliers.
Answer: False
Explanation: Deferred expenses are classified as assets because they represent future economic benefits from costs paid in advance, not obligations to suppliers.
How are deferrals generally represented on a company's balance sheet?
Answer: As either assets or liabilities
Explanation: Deferrals are represented on the balance sheet as either assets (e.g., deferred expenses) or liabilities (e.g., deferred revenue), depending on their nature and the obligation or benefit they represent.
Deferred charges are typically carried on the balance sheet as:
Answer: Non-current assets
Explanation: Due to their long-term nature and the extended period over which their benefits are realized, deferred charges are typically classified as non-current assets on the balance sheet.
Deferred revenue is classified on the balance sheet as:
Answer: A liability
Explanation: Deferred revenue represents an obligation to provide future goods or services, and is therefore classified as a liability on the balance sheet.
Deferred expenses are classified on the balance sheet as:
Answer: An asset
Explanation: Deferred expenses, representing costs paid in advance for future benefits, are classified as assets on the balance sheet.
Accrued revenue involves cash paid for future benefits, similar to deferred expenses.
Answer: False
Explanation: Accrued revenue pertains to revenue earned but not yet received in cash, representing an asset. Deferred expenses involve cash paid for future benefits, representing an asset. They are distinct concepts, though both relate to timing differences.
Deferred revenue and accrued expenses represent the same type of obligation.
Answer: False
Explanation: Deferred revenue represents an obligation to deliver goods or services (liability to a customer), while accrued expenses represent an obligation to pay for goods or services already received (liability to a supplier). They are distinct types of obligations.
How does accrued revenue differ conceptually from a deferred expense?
Answer: Accrued revenue recognizes earned income before cash receipt, while deferred expense is cash paid for future benefits.
Explanation: Accrued revenue represents income earned but not yet received (an asset), whereas a deferred expense represents cash paid for future benefits (also an asset). The key difference is the nature of the underlying transaction: earning revenue versus incurring an expense.
How does deferred revenue differ from accrued expenses?
Answer: Deferred revenue is an obligation to deliver; accrued expenses are obligations to pay.
Explanation: Deferred revenue represents a liability to deliver goods or services, arising from cash received in advance. Accrued expenses represent a liability to pay for goods or services already received.
What is the fundamental difference between deferred revenue and a liability for accrued expenses?
Answer: Deferred revenue is a liability to a customer, accrued expense is a liability to a supplier.
Explanation: Deferred revenue represents a liability to a customer for services or goods not yet provided, while accrued expenses represent a liability to a supplier for services or goods already received.