A deferred charge is a cost that has been paid for in the present, but it will be spread over a long period and be accounted for at a future date. Deferred charges may include professional fees and the amortization cost (lose of value) of intangible assets, such as copyrights and research and development. Prepaid expenses, on the other hand, are costs that the business pays in advance prior to when the costs are actually incurred. Prepaid expenses may include items such as rent, interest, supplies and insurance premiums. Deferred charges and prepaid expenses are different in various ways and these differences should always be considered when accounting for them.
Prepaid expenses relate to a specific time frame, that is, the prepaid transactions must occur within a year. For example, the expense transaction for prepaid rent lasts for a period of 12 months. Deferred charges, on the other hand, have a longer transaction time frame that exceeds one year over which they are spread through gradual charges. Interest on long-term loan, for example, is spread over the repayment period of the loans that may be spread over a period of 10 years.
Prepaid expenses occur on a predetermined routine basis, such that the business requires to consume these expense items continuously to facilitate the different functions and activities. For example, the rent and insurance premiums occur regularly and these expense items are extremely necessary in facilitating the activities of the business. Deferred charges, on the other hand, do not occur frequently because they are linked to the strategic plans of the business that are spread over a long period of time. For example, professional fees are incurred on rare occasions.
Accounting Differences of Prepaid Expenses
Prepaid expenses are posted as assets in the books of accounts and then consumed in equal intervals until they are exhausted. In accrual accounting entries, a prepaid expense amount is posted as a credit entry in the prepaid expenses account and classified as a current asset. The credit entry is posted to the accounts payable account. The installments for the monthly charges for the prepaid expense are then posted as debit entries in the cash account and as credit entries in the specific supplier account.
Accounting Differences of Deferred Charges
Deferred charges are spread over several accounting periods. In accounting, the costs of deferred charges are not posted every month, but rather, are posted as accumulated figures for a given period after the costs have been incurred. Unlike prepaid expenses that are posted and charged to accounts on a monthly basis, deferred charges are paid in lump sum figures. As for the posting, a deferred charge amount is posted as a credit entry in the deferred charges account and classified as a current asset. The credit entry for the transaction is posted to the accounts payable account. The installments for the accumulated charges of several months for the deferred charges are then posted as debit entries in the cash account and as credit entries in the specific supplier account.