Accrued income is that which has been earned but not received or recorded by the end of the accounting period. In other words, the accruals of income are recognized when they are earned and not when cash is received. From this, it becomes an asset in the company’s books, representing the entitlement to receive money in the future. Accrued income would be required to match revenues with the period in which they are earned, thereby ensuring accurate financial reporting as well as compliance with accounting principles.
What is Accrued Income?
Accrued income is the income that a business earns but does not collect for its accounting period. This takes place when services have been provided or the products delivered, but their accompanying payment has not been collected for the accounting period. For example, a company renders consulting in December but collects the money for it only the following month. Therefore, the income would be recognized as accrued in that case. It would be recognized in the current period to match the revenue with the expenses incurred to generate it, which is the primary principle of accrual accounting.
Accrued income is considered an asset in the balance sheet because it represents a future economic benefit. It is not without importance, however, as ensuring that the financial statements of a firm will indeed reflect the firm’s actual financial performance for a period, regardless of whether cash transactions have occurred or not.
Accrued Income Journal Entry
Accrued income journal entry records income earned but not received. This entry results in debiting an asset account, for example, accrued income or accounts receivable and crediting an income account. Thus, though payment is received later, it will be recorded in the proper period.
Example of an Accrued Income Journal Entry
Example: A company provides legal services worth $5,000 in December but will receive payment in January.
Journal Entry (December 31st):
| Debit: Accrued Income (or Accounts Receivable) $5,000 Credit: Service Revenue $5,000 |
This entry records the income in December, the period in which the service was rendered, even though the cash will be collected later. When the payment is received in January, the following entry is made:
Journal Entry (January when paid):
| Debit: Cash/Bank $5,000 Credit: Accrued Income (or Accounts Receivable) $5,000 |
This method ensures that income is recognized when earned, aligning with the accrual accounting principles and providing a true picture of the company’s financial position.
Accrued Income Example
To better understand accrued income, let’s look at a practical example:
Example: ABC Ltd. provides website maintenance services for $2,000 in December, with the payment expected in January. According to the accrued income concept, ABC Ltd. must record the income in December, even though the payment will be received in January.
Accrued Income Journal Entry (December 31st):
| Debit: Accrued Income $2,000 Credit: Service Revenue $2,000 |
This journal entry ensures that the income is recognized in December, the period in which the service was provided.
Payment Entry (January):
| Debit: Cash/Bank $2,000 Credit: Accrued Income $2,000 |
The accrued income account is cleared when the payment is received, demonstrating how accrued income ensures that financial statements reflect earned revenues, even if payment occurs in a later period.
Features of Accrued Income
Accrued income has several key features that make it an essential part of the accrual accounting system. These include:
Income Recognition
Accrued income follows the accrual accounting principle of recognizing income when earned, not necessarily when cash is received. This way, financial reporting by the company is reflected correctly since it has occurred within the proper accounting period.
Asset Classification
Accrued income represents the company’s legal right to receive cash in the future and is accounted for as an asset in the balance sheet, although there is no payment yet. This suggests that the company has even earned the income, though payment has not been made yet.
Matching Principle
Accrued income deals with the matching principle, according to which revenues must be matched with expenses incurred to generate such revenues. The principle will ensure that incomes are accounted for in the same accounting period as their respective expenses and will hence reflect true profitability properly.
Temporary Account
Accrued income is a temporary account since it exists only until the income is received. The accrued income account is cleared while cash or bank is credited with the amount once payment is made.
Consistency in Reporting
By recording accrued income, businesses ensure consistency and accuracy in their financial statements, making it easier to analyze financial trends and performance over time.
Applicable in Various Industries:
Accrued income is common in industries such as professional services, real estate, insurance, and utilities, where services are provided, or products are delivered, and payment is received at a later date.
Is Accrued Income a Debit or a Credit?
Accrued income is an asset account of the firm since it arises from a right to receive cash in the future. Therefore, accrued income is recorded as a debit in the books of the company. When income is earned but not received, the account (or accounts) under the account “accrued income,” or, more generally, accounts receivable is debited, thus the assets are increased on the balance sheet. Meanwhile, an account related to a corresponding account called “Service Revenue” is credited, reflecting the earned revenue in the company’s income statement.
Here’s how the entry works:
Debit: Accrued Income (Asset) – Increases the asset on the balance sheet.
Credit: Revenue – Increases the revenue on the income statement.
When the payment is finally received, the accrued income account is credited, and the cash or bank account is debited.
Example: A company has earned $3,000 in consulting fees but will receive the payment next month.
Accrued Income Journal Entry:
| Debit: Accrued Income (Asset) $3,000 Credit: Consulting Revenue (Income) $3,000 |
This entry records the income when earned. When the payment is received:
Payment Entry:
| Debit: Cash/Bank $3,000 Credit: Accrued Income $3,000 |
This clears the accrued income and recognizes the cash received.
Conclusion
Accrued income is an essential component of accrual accounting since it ensures that the business recognizes income when earned and not when cash is received. Therefore, this is how accrual accounting will help a business fulfill the requirements of the matching principle and further ensure that its financial statements are made correctly. Accrued income is an asset on the balance sheet; more so, a company’s right to receive future payments. Understanding the accounting treatment of the accrued income is crucial for all types of businesses in the equation because for managing basic transparency and consistency in financial statements, it is very important.
Accrued Income FAQs
What is accrued income?
Accrued income refers to income that has been earned but not yet received by the end of the accounting period. It is recorded as an asset on the balance sheet.
How is accrued income recorded in the journal?
Accrued income is recorded by debiting the accrued income (or accounts receivable) account and crediting the relevant revenue account.
Can you give an example of accrued income?
An example of accrued income is when a business provides consulting services in December but receives the payment in January. The income is recorded in December as accrued income.
Is accrued income a debit or a credit?
Accrued income is a debit because it represents an asset, specifically the right to receive cash in the future.
Why is accrued income important in financial reporting?
Accrued income is important because it ensures that income is recorded in the correct accounting period, providing a true and fair view of the company’s financial performance.
