Deferred Liabilities Explained

Cash in the balance sheet must have been earned, meaning that deposits or payments in advance of delivery will be set off using deferred liability.

Deferred Revenue as a Deferred Liability

Cash that has been received for a transaction that is yet to be completed is known as deferred revenue. This has to be removed from the balance sheet by way of an entry - Deferred liability.

For example, if your company has received £1,000 as an advance paymente for goods that are yet to be shipped by the time accounts become due, that cash forms part of current assets in the balance sheet.

However, because it has not yet been earned it then has to be deducted by creating a £1,000 deferred liability.

Deferred Liability for Ring-Fenced Cash

Another example can be for something like a charity, campaign or political party where cash donated is ring-fenced to be used for a specific purpose concerning an event such as an election or a referendum that has yet to take place.

The intended purpose represents a restriction meaning that the rules will be the same as for prepayment of goods. Again, if the specified event has not yet taken place the balance sheet must include a deferred liability to remove the value of the donation.

Defererred Liabilities and Liquidity

If settlement of a deferred liability is to take place within a year, it is recognised as being part of current liabilities, meaning that both shareholders funds (equity) and net current assets (balance sheet liquidity) will be reduced.

If settlement is for greater than a year, it becomes a long-term liability which does not therefore immediately reduce liquidity. For that to work though a specific date upon which settlement is to take place must be contractually evident otherwise its liability can be recognised as being on-demand and therefore current.

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