Introduction
A business may have miscellaneous forms of
income, for example, from renting out property.
When a business entity has income from
sources where payments are made in advance or in arrears. The accruals basis of
accounting applies, and the amount of income to include in profit and loss for
a period is the amount of income that relates to that period. It may therefore
be necessary to apportion income on a time basis and there may be unearned
income or accrued income to account for.
Unearned income
This is where a business has received income
in advance. For example, a business might rent out a property for which the
tenant must pay in advance. Only the income that relates to the period is
recognised in the statement of comprehensive income and the balance is
recognised as a liability of the business. (Note that it is an asset of the
tenant).
The method of calculating income for the year when there
is unearned income is the same in principle as the method of calculating an
expense for the year when there is an accrued charge or a prepaid expense.
Example: Unearned income
A
business rents out a part of its premises.
The
rent is payable every six months, on 1 May and 1 November in advance.
The
company has a year end of 31 December.
The
annual rental for the year to 30 April 2013 was Rs. 48,000 (received in two
amount so of Rs.24,000 on 1 May 2012 and 1 November 2012).
The
annual rental and Rs. 60,000 for the year to 30 April 2014 (received in two
amount so of Rs.30,000 on 1 May 2013 and 1 November 2013).
Income
for the year ending 31 December 2013 is:
For
the 4 months 1 January – 30 April 2013:
4/12 ´ Rs. 48,000
16,000
For
the 8 months 1 May – 31 December 2013:
8/12 ´ Rs. 60,000
40,000
Rental income for the year to 31
December 2013 56,000
At
31 December 2012 there was unearned rental income for the period 1 January – 30
April 2013.
The
amount of unearned income is 4/12
of the Rs. 24,000 received on 1
November 2012 which came to Rs. 16,000. (This represents 4 months at Rs. 4,000
per month)
This
was included as a current liability in the statement of financial position as
at the end of the last financial year.
At
31 December 2013 there is unearned rental income for the period 1 January – 30
April 2014.
The
amount of unearned income is 4/12
of the Rs. 30,000 received on 1
November 2013 which comes to Rs. 20,000. (This represents 4 months at Rs. 5,000
per month)
This
is recognised as a current liability as at the end of the financial year.
Unearned income (just as for prepayments and accruals)
can be accounted for using either one or two accounts to record the transactions.
If two accounts are used the closing unearned income liability must be reversed
to the income account at the start of the next period (just as is the case for
prepayments and accruals).
Approaches for unearned income
- Method 1
- Method 2
Method 1: Two accounts method
Income has been paid to the business but some
of it relates to the next period.
This amount must be transferred from the
income account to a liability account
Example: Unearned income
Debit Credit
Income X
Unearned income (liability)
X
Example (continued): Unearned income
The double entry is
as follows:
 |
| Unearned income |
Method 2: One account method
The unearned income is brought down as a
liability on the income account.
There are two ways of achieving this.
The total income for the period can be calculated and transferred
to the statement of comprehensive income (Dr Income account; Cr Statement of comprehensive
income) leaving a balancing figure on the expense account as the unearned
income liability; or
The unearned income liability can be calculated and recognised in
the expense account leaving the amount transferred to the statement of comprehensive
income (Dr Income account; Cr Statement of comprehensive income) as a balancing
figure
Example
(continued): Unearned income (One account approach)
The double entry is as follows:
 |
| Unearned income |
Accrued income
This is where a business receives income in
arrears. For example, a business might rent out a property for which the tenant
must pay in arrears. The tenant might owe the business money at the business’s
year-end.
All of the income that relates to the period
must be recognised in the statement of comprehensive income. It is necessary to
recognise the amount owed to the business as an asset at the year-end.
The method of calculating income for the year when there
is accrued income is the same in principle as the method of calculating an
expense for the year when there is an accrued charge or a prepaid expense.
Example:
Accrued income
A
business rents out a part of its premises.
Rentals
are payable each quarter in arrears on 31 January, 30 April, 31 July and 31
October.
The
company has a year end of 31 December.
The
annual rental was Rs. 30,000 per year until 31 October 2013 (or Rs. 2,500 per
month received in 4 amounts of Rs.7,500 on 31 January, 30 April, 31 July and 31
October).
The
annual rental was increased to Rs. 36,000 per year from 1 November 2013 (or Rs.
3,000 per month received in 4 amounts of Rs.9,000 on 31 January, 30 April, 31
July and 31 October).
Income
for the year ending 31 December 2013 is:
Rs.
For
the 10 months 1 January – 31 October 2013:
10/12 ´ Rs. 30,000
25,000
For
the 2 months 1 November – 31 December 2013:
2/12 ´ Rs. 36,000
6,000
Rental
income for the year to 31 December 31,000
At
31 December 2012 there was rental earned but not yet received.
This
is the rental income for November and December 2012, which will not be received
until 31 January 2013.
The
amount of the accrued income is Rs. 5,000 (2/3
of 7,500 or 2 months at Rs.
2,500 per month) and was included in last year’s income and recognised as a
current asset at the end of last year financial year.
At
31 December 2013 there is rental earned but not yet received.
This
is the rental income for November and December 2013, which will not be received
until 31 January 2014.
The
amount of the accrued income is Rs. 6,000 (2/3
of 9,000 or 2 months at Rs.
3,000 per month) and is included in income and recognised as a current asset at
the end of the financial year.
Accrued income (just as for prepayments and accruals) can
be accounted for using either one or two accounts to record the transactions.
If two accounts are used the closing accrued income asset must be reversed to
the income account at the start of the next period (just as is the case for
prepayments and accruals).
Approaches for Accrued Income
- Method 1
- Method 2
Method 1: Two accounts method
Income has been earned in the current period.
This amount must be recognised.
Example: Accrued income
Debit Credit
Accrued income (asset) X
Income X
Example (continued): Accrued income
The double entry is
as follows:
 |
| Accrued income |
Method 2: One account method
The accrued income is brought down as an
asset on the income account.
There are two ways of achieving this.
- The total income for the period can be calculated and transferred to the statement of comprehensive income (Dr Income account; Cr Statement of comprehensive income) leaving a balancing figure on the expense account as the accrued income asset; or
- The accrued income asset can be calculated and recognised in the expense account leaving the amount transferred to the statement of comprehensive income (Dr Income account; Cr Statement of comprehensive income) as a balancing figure
Read Also:ACCRUALS AND PREPAYMENTS INTRODUCED
Example (continued): Accrued income (One account approach)
The double entry is
as follows:
 |
| Accrued income (One account approach) |
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