Income Received in Advance – A Current Liability by nature

The success or failure of the organisation largely depends on the business decisions taken by the management. Company’s decisions will highly impact the profit or loss of the company and thus it is extremely important for the company to follow right accounting treatment to analyse the true profit or loss of the company.

 

 

What is right accounting? Right accounting is nothing but following the right accounting practices. The business records will depict true profit when a company follows Accrual basis of Accounting.

Under Accrual Basis of Accounting the treatment for accruals become very critical. One such items is Income Received in Advance.

 

If an income that belongs to a future accounting period is received in the current accounting period it is considered as Income Received in Advance, also known as Unearned Income. This type of income is received before the related benefits are provided. In this case the company that receives the money will not earn it and it will have an obligation to deliver the related goods or services in the future. Under the accrual method of accounting, income received in advance is considered to be a current liability.

 

Following accounting entry is required to account for Income Received in Advance:

At the time of Receipt:

Cash/Bank A/c                                    Dr.

To Prepaid Income A/c

 

At the time of year-end adjustment:

Prepaid Income                       Dr.

To Income A/c

 

 

Let us understand with an example:

ABC & Co received AED 36,000/- as Rent for the period 1st April, 2016 to 31st March, 2017 on 7th April, 2016.

For the Financial Year ending 31st December, 2016, office space is only going to be occupied for 9 Months and the charges for that period comes to (36,000*9/12) = AED 27,000/-

Hence the total excess amount received comes to AED 9,000/- (36,000-27,000).

The adjusting entry for prepaid revenue results in a debit to liability account and credit to a revenue account

 

So, the accounting entries will be as follows:

 

At the time of Receipt:

Cash/Bank A/c                                                Dr.       36,000

To Prepaid Income A/c                                   36,000

 

At the time of year-end adjustment:

Prepaid Income                                   Dr.       27,000

To Income A/c                                                 27,000

About the author

FAME is a leading Accountancy training provider. FAME brings together under one roof a wide range of accounting courses blended with real world experience and practical application. FAME aims to bridge the gap between theoretical knowledge and practical challenges that accountants face in their day to day working. We provide practical workplace skills for finance staff meeting the needs of employers, bankers, government and learners, both now and in the future. Our students are integral to the success of an organisation and at the heart of ensuring the smooth running of an accounting department.