Definition of Accrued Income
Accrued income, under the accrual accounting system, is the income of a company or a business that has been earned during a certain period by selling products and/or services but the payment for which has not been received.
Accrued income is a useful concept in accounting and finance. Most companies use accrual accounting for the purpose or reporting and taxation. It is different from cash accounting. Accrual income is the income that a company records in its books of accounts as and when the products and services are delivered irrespective of whether cash is received or not.
Examples of Accrued Income
A junior accountant at Creditpay Ltd. has to record the interest income the company receives every month from the bank on a deposit of $25,000. The complexity involved is that the interest income of the preceding month is credited to Creditpay account in the first week of the next month. For instance, the interest income of March will be credited in April, and so on.
What should be the entry of this income in the books of accounts?
The following entry is valid before any interest payment is received
Once Creditpay Ltd. receives the interest the following entry will be recorded
How to Record Accrued Income?
Accrued income follows the matching principle. It is recorded in the same accounting period in which it is recognized and not earned. Take for example a furniture company that has sold cupboards and kitchen tables worth $500,000 in the quarter ending Mar 31, 2020. The purchasing company will pay the furniture company in the quarter ending Jun 31, 2020. However, the furniture company should record this accrued income in the accounting period when it was recognized i.e. quarter ending Mar 31, 2020.
Similarly, accrued interest income will also follow the same recording principle. Any accrued interest will be recorded as ‘interest receivable in the period it has been recognized even if the payment is expected to be received on a later date.
Accrued Income on Balance Sheet
On a balance sheet, accrual income will be reported in the current asset section. Accrued income can also be found in the receivable items in the current asset section, if not found by accrued income as a separate item.
An increase or decrease in the accrued income is reported simultaneously in the retained earnings section as well in the stockholder’s equity.
Journal Entry for Accrued Income
Journal entries for accrued income are important from the perspective of accounting as it help in the preparation of trial balance, ledger, and finally the balance sheet. If a company makes an interest income of $50,000 of which $20,000 is not received, what will be the journal entry?
As long as the interest is not received, the journal entry for the receivable part will be as follows:
The interest that has been paid i.e. $30,000 will be recorded as follows:
Importance of Accrued Income
Under the United States GAAP provisions, accrual accounting uses the principle of revenue recognition to match the revenues earned in a period instead of when the cash for that earned revenue is received. Revenue recognition provides for matching the revenue earned with the cost/expenses incurred within the same period.
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As regards the individuals working for employers, accrual income is the income that they earn for the work that has been performed. Accrual income takes recognition of the working days/hours that the individual has worked, an equivalent income is recorded for which he is eligible to be paid (may be weekly or monthly).
Advantages
Some of the advantages are given below:
- Accrual accounting provides the correct picture of business’ cash flows
- Accrual accounting takes into consideration the impact of accrued income over several accounting periods and thus records accrued income in the period of recognition
- Accrued income is a useful line item in accounting methods under US GAAP thus bringing consistency of standard practices and accuracy in reporting
- Accrued income also gives the potential of what how much the company has delivered as on a given date or during a given period
- Accrual accounting allows for ease in planning because of reporting the revenues and expenditures in the same accounting period. This brings reporting to a uniform and cohesive level
Disadvantages
Some of the disadvantages are given below:
- Accrual accounting may present challenges to smaller business as they may need the expertise to manage these accounts
- Accrual basis demands lengthy reporting formats as opposed to accounting done on a cash basis; this is due to the splitting of items such as interest income and accrued income over a longer period
- Nevertheless, the business cannot escape taxes by any means when using accrual accounting. If the income is recognised before it is actually earned, so are the taxes paid before the income is received
- If misused, accrual accounting can create chances for management or executives to report sales and revenues so as to gain the benefits of incentives and commissions
- Accrual accounting can paint a complicated and untrue picture of a business if the business has cyclical or seasonal earnings
Conclusion
The basis for accrual accounting is the principle of revenue recognition as stated in the U.S. GAAP. Accrued income and accrued interest income are both important concepts in accounting and finance. It should be noted that the concept can sometimes be applied to revenue that has not yet been paid. Such accrued revenue is recorded in the period of recognition and should match the period of expenses incurred. One important advantage of accrual accounting is that it smoothens out earnings over a significantly longer time period.
The concept of accrual income is also important for individuals. Salaried individuals are paid on weekly or monthly basis even if they perform work or labor before getting paid. An important difference between both types of accounting that goes in favour of accrual accounting is that companies having larger accounting payables instead of cash & cash equivalents thus misguiding investors to be cash rich. Cash accounting in such cases lead to bad-debts and the creation of contra accounts.
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This is a guide to Accrued Income. Here we also discuss the definition and how to record accrued income? along with advantages and disadvantages. You may also have a look at the following articles to learn more –
