Page 49 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes 3.1.6 Deferred Income

Deferred income is the converse of accruals. It is income received during an accounting period,
but for which the company has not yet supplied the goods and services as at the end of the
period, so which cannot be recognised as income. These amounts should not be included in the
Profit & Loss for the period.

An item that gives rise to deferred income is the other side of a prepayment. Where a buyer has
a prepayment, its supplier will have deferred income.

Notes Accruals and deferred income are often shown as a single balance sheet item. Some
companies disclose them separately, which is useful for financial modelling, because it
makes future revenues more visible.
Deferred incomes are incomes received in advance by the firm for supply of goods or services in
future period. These income receipts increase the firm’s liquidity and constitute an important
source of short-term source finance. These payments are not showed as revenue till the supply
of goods or services, but showed in the balance sheet as income received in advance. Advance
payment can be demanded by only firms having monopoly power, great demand for its products
and services and if the firm is manufacturing a special product on a special order.

Case Study Essel Corporation

ssel Corporation is seeking to raise short-term funds by factoring receivables. It
has talked with two factors and is trying to decide which factor to use. Factor A
Echarges 3.5 per cent factoring commission on gross invoices. Interest rate is 1 per
cent per month on the gross invoice amount. Factor A requires that 5 per cent of the gross
invoice amount be placed in a reserve until the account has paid. Factoring would be with
recourse. Factor B charges 4.0 per cent factoring commission on the gross invoice amount
and 1.0 per cent per month interest on the invoice amount less factoring commissions and
reserve (which is 5 per cent of the invoice amount). Factoring is without recourse.
1. Assume that Essel wants to immediately factor ` 1,00,000 in receivables and borrow
the maximum amount allowed. What is the amount of the loan it will receive from
factor A and Factor B? You may assume that the receivables to be factored will
average a collection period of one month.
2. Essel wishes to enter into a continuous long-term factoring arrangement with either
factor A or factor B. What does it need to consider before selecting A or B? Should
Essel give its business to A or B? Support your answer with illustrations/examples.

Self Assessment

Fill in the blanks:
8. The goal of every accountant is to present fairly the .......................... of the business.
9. The main advantages of trade credit are .......................... , .......................... and ..........................

10. The amount of accrual varies with the level of .......................... of a firm.

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