Accrued Expenses and Deferred Income - Financial Management

Accrued Expenses and Deferred Income

Accrued expenses and deferred income are additional spontaneous sources of unsecured short-term credit.

Accrued Expenses

Accrued expenses—such as accrued wages, taxes, and interest—represent liabilities for services rendered to the firm that have not yet been paid for by the firm. As such, they constitute an interest-free source of financing.

Accrued wages represent the money a business owes to its employees.Accrued wages build up between paydays and fall to zero again at the end of the pay period, when the employees receive their paychecks. A company can increase the average amount of accrued wages by lengthening the period between paydays. For example, changing from a 2-week pay cycle to a 4 -week pay cycle would effectively double a firm’s average level of accrued wages. Also, a company can increase accrued expenses by delaying the payment of sales commissions and bonuses. Legal and practical considerations, however, limit the extent to which a company can increase accrued wages in this manner.

The amounts of accrued taxes and interest a firm may accumulate is also determined by the frequency with which these expenses must be paid. For example, corporate income tax payments normally are due quarterly, and a firm can use accrued taxes as a source of funds between these payment dates. Similarly, accrued interest on a bond issue requiring semiannual interest payments can be used as a source of financing for periods as long as six months. Of course, a firm has no control over the frequency of these tax and interest payments, so the amount of financing provided by these sources depends solely on the amounts of the payments themselves.

Deferred Income

Deferred income consists of payments received for goods and services that the firm has agreed to deliver at some future date. Because these payments increase the firm’s liquidity and assets—namely, cash—they constitute a source of funds. Advance payments made by customers are the primary sources of deferred income. These payments are common on large, expensive products, such as jet aircraft. Because these payments are not “earned” by the firm until delivery of the goods or services to the customers, they are recognized on the balance sheet as a liability called deferred income.

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