What is Accrued Income?
Accrued income is income that a company will recognize and record in its journal entries when it has been earned, even though cash has not been received. There are times when a company will record a sales revenue even though they have not necessarily received cash from the customer for the service performed or goods sold. A perfect example is when customers purchase goods on account or pay for a service on account. The term “on account” means that customers do not necessarily pay at the time of purchase. In such situations, companies recognize that they are selling goods or performing a service even if they did not necessarily receive cash, which is accrued revenue (income).
How to Record Accrued Income?
Similar to accrued expense, accrued income is recorded in the period in which it is recognized even though cash has not been exchanged. We offer an example below to demonstrate this. Please note that all examples are done using Excel and if you are unfamiliar with the application, be sure to check out our free Excel crash course.
On March 31, 2017, Corporate Finance Institute received $75,000 cash as an advance for their online resources from Lasdo Company. Corporate Finance Institute will issue those online resources on April 15.
Notice that we use an account called “unearned sales revenue” to demonstrate that the revenue has not necessarily been earned yet. This is similar to a payables account, which we empty out into actual sales revenue when we receive the payment.
Once Corporate Finance Institute actually issues those online resources to Lasdo Company, they will then debit unearned sales revenue and credit sales revenue by the same amount. This is to demonstrate that they have now earned their revenue whereas before, it was unearned because CFI did not issue the resources yet.
Importance of Accrued Income
Accrued income is very important in accounting because companies receive advances for their goods or services all the time. To prevent overstating certain accounts, companies need to differentiate between the revenue that they have earned versus revenue that they have not earned yet.
A perfect example of where things can go wrong is when companies do not differentiate between earned and unearned revenue and keep putting accrued revenue into the revenue account. When this lack of differentiating occurs, it leads to an overstatement of both revenue and net income. Thus, the financial statements are all affected.
Therefore, understanding the concept of accrued income and accrual basis accounting is key to avoiding errors made in the financial statements.
Accrued Interest Revenue
Another type of accrued income is known as interest revenue (income). This usually occurs when companies have interest-bearing promissory notes issued by their customers. A promissory note is issued by a customer to an organization that states that a certain amount will be paid by a certain date with or without added interest. To see what interest revenue looks like on a financial statement, check out our financial statements for banks article.
On April 1, 2017, Corporate Finance Institute had an outstanding accounts receivable balance from Lasdo Company valued at $3,000. Lasdo Company prepared a notes payable and issued it to Corporate Finance Institute stating that they would pay off their outstanding fee plus 1% annual interest by the end of the year.
To record the issuance of the note from Lasdo Company, Corporate Finance Institute will record this entry:
There are two things to note here: first, we are recording this from the perspective of Corporate Finance Institute, which is why we have notes receivable instead of notes payable. Second, recall that Lasdo Company had an outstanding debt of $3,000. In this entry, we transfer all of Lasdo Company’s outstanding debt into Corporate Finance Institute’s notes receivable.
The next entry that we need to record is the accruing of interest in May:
This is similar to the accrued interest expense entry. Here, we take the outstanding $3,000, multiply it by 0.01 (1%) and then divide by 12 to find the monthly interest.
The last entry, which we record at the end of the year because Lasdo Company pays it back on December 31, is as follows:
Interest receivable is credited for $20 to transfer all of the accrued interest to cash. Interest revenue is credited for $2.50 to record the interest in the last month (December). We also have notes receivable being credited at its entire amount to demonstrate that it has been paid off by Lasdo Company. Notice here that in the description of our journal entry we say that Lasdo Company has “honored” their notes receivable. Honoring of notes receivable simply means that the note was paid within the time period stated.
Should Lasdo Company not pay off their notes receivable in time, then we would have a dishonoring of notes receivable. Corporate Finance Institute would then have to decide whether or not Lasdo Company will pay back their outstanding balance. This is known as a bad debt expense to Corporate Finance Institute.
If you think you have mastered accrued income, then be sure to check out these related articles to get a better understanding of accrual basis accounting and other topics in accounting: