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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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  • Deferred And Prepaid Assets – And What They Mean 0 comments
    Jun 29, 2013 10:16 AM

    Some terminology on the corporate balance sheet is confusing and vague. As difficult as it is for any non-accountant to struggle with the real meaning of categories, many - like "deferred assets" and "prepaid expenses" do not make matters easier.

    Several sources mix "deferred assets" and "prepaid expenses" as one and the same, but there are clear and important differences. Both accounts result from the importance of timing and recognition. Companies are supposed to "recognize" all income, costs and expenses in the applicable year. For example, if any income or expenses is paid in the wrong year, it is supposed to be deferred until the proper year.

    A deferred asset is one such item. It is anything paid in the current year that should not be recognized until the future. For example, near the end of the current fiscal year, a company makes a large payment for merchandise. However, it will not show up in the warehouse or count as part of inventory until next year. Instead of counting this inaccurately as the cost item, "Merchandise purchased," the company sets it up in the asset section of the balance sheet as a deferred asset. This will be reversed and booked into direct costs next year.

    The same treatment applies if income is received before the year it is earned. For example, if a customer pays in advance for goods that are not delivered until next year, it is booked in the liability section as a "deferred credit" or "deferred income."

    Some people consider deferred and prepaid as the same, but they are not. A deferral is a timing difference - cost or expense paid this year but not applicable until next, for example. A prepaid asset is different.

    When a company prepays an expense that applies over a period beyond the current year, it is set up as a prepaid asset and then amortized over the full period. For example, in the current fiscal year, a company prepays a 36-month insurance premium. The proper treatment of this transaction is to set it up as a prepaid asset and then transfer 1/36th each month over the next 36 months.

    These might seem like minor differences, but the significance of deferrals and prepays is quite important. Whether booked in the wrong year as a timing difference or paid in advance and extending over more than one fiscal year, the intention behind this system is important: It ensures that income, costs and expenses are booked into the proper year. In this way, the costs and expenses showing up on the income statement are related specifically to the revenue also booked that year.

    In some cases, the dollar amounts are very minor. However, in other instances, it can involve millions of dollars and a substantial impact on profits. It may seem complicated that the accounting system has to include these in-and-out adjustments, but the overall intention is to improve the accuracy of what is reported to stockholders.

    To gain more perspective on insights to trading observations and specific strategies, I hope you will join me at ThomsettOptions.com where I publish many additional articles. I also enter a regular series of daily trades and updates. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site at ThomsettOptions.com to learn more. As a new member, if you buy a one-year subscription, you also get a free copy of one of my books, including this new one recently released.

    I also offer a bi-weekly newsletter subscription if you are interested in a periodic update of news and information and a summary of performance in the virtual portfolio that I manage. The newsletter is free until August 1; after that, it requires a paid subscription, but members can subscribe for a reduced rate. Join at Weekly Newsletter I look forward to having you as a subscriber.

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