We all know that accounting is nothing but number crunching. Accountants simply add numbers and subtract numbers while drinking copious amounts of coffee. Just kidding. Go hug your accountant or your closest accounting student, because accounting is a challenging process of measuring, validating, and reporting financial information for an entity.
Most would say that accounting is the language of business, and without it, you can’t talk the talk. Just like any language, there are words that cause great confusion for those learning it for the first time. Here are a couple of accounting terms that disgruntle fresh-faced accounting students (as well as established accounting professionals):
You see the word revenue and automatically think, ‘REVENUE, REVENUE, REVENUE! Money is immediately coming my way!’ Put on the breaks there, pal. What if I told you that Deferred Revenue is actually a liability, an obligation to pay? You saw the word revenue, but did you happen to see that word in front of it—DEFERRED? This means that you can’t claim any revenue just yet. Some people find it helpful to use the word ‘unearned’ as opposed to ‘deferred’ to make it clear that the revenue isn’t yet realizable.
Unearned/Deferred Revenue is a liability account that represents the obligation to provide goods or services to a customer in the future. Unearned/Deferred Revenue is recorded when a business receives a payment in advance from a customer, but the business has not yet delivered the good or provided the service. Once the business fulfills its obligation to provide goods or services, the liability is reduced and the revenue is recognized. Say it with me, ‘Unearned/Deferred Revenue is not a revenue account!’
You see the word expense and automatically think, ‘EXPENSE, EXPENSE, EXPENSE! Wait, wait, is this similar to Deferred Revenue? Where the word ‘prepaid’ makes the word ‘expense’ behave differently?’ Yes, you got it! Prepaid Expense is in fact NOT an expense account, but rather an asset account.
A Prepaid Expense is an asset that represents the right to receive goods or services in the future. Some common examples are prepaid rent or prepaid insurance, where a company pays for rent or insurance in advance of the coming month or year. At the time of the payment, the transaction is recorded as an asset, and as time passes, the asset is reduced and the expense is recognized. Say it with me, ‘Prepaid Expense is not an expense account!’
Want to learn the language of business and develop an essential understanding of financial accounting, business analytics, and economics for managers? You may be interested in HBX CORe, an interactive online program from Harvard Business School!