September 2020
Gareth John explains all you need to know about accrued and deferred income.
In our financial statements we always need to make sure that we are correctly recognising the income and expenses of our business during the accounting period that they relate to. This is the accruals, or ‘matching’, concept.
Most students work hard to understand how the use of accruals and prepayments ensures that expenditure is allocated to the correct accounting period, but often find applying the same principles to income harder to grasp. In this article we explain accrued and deferred income and how we post journal entries for them.
Always remember that under the accruals concept it doesn’t matter when a sale is actually paid for by a customer, or when we send out the invoice for work completed. All that matters is whether we have done the work to ‘earn’ the income.
• Sometimes we might invoice in advance for work being done at a later date.
• Sometimes we might have done the work but not yet issued an invoice.
Income from a ‘normal’ cash sale
If we earn some income by delivering goods to a customer and the customer pays for those goods immediately, then the double entry is:
Dr Cash (the asset that we now own)
Cr Sales (the income that we have ‘earned’ from delivering the goods; we have done the work!)
This is a cash sale.
Income from a ‘normal’ credit sale
with an invoice If we earn income by delivering goods to a customer and they do not pay immediately, this is often because we offer them a credit period. At the point of the sale we would normally send them an invoice as a request for payment.
The double entry for this is:
Dr Sales ledger control account (the asset of the receivables balance owed by the customer)
Cr Sales (we have still ‘earned’ income by delivering the goods even if we haven’t been paid yet)
This is a credit sale. Note that the credit is still made to the sales account as we have still done the work.
Accrued income
Now, what if we have delivered goods to a customer who we offer credit to, but we haven’t issued an invoice yet? We still need to recognise the income earned as we have delivered the goods, but because there is no sales invoice to record in the sales day book, there would be no entry made to the sales ledger control account.
We therefore need to recognise another form of receivable. This is income that we have ‘earned’ by doing the work, but that will be invoiced at some point in the future; this is called accrued income.
The double entry for this is:
Dr Accrued income (again, an asset that we are owed for the work we have done. Think of this as an ‘un-invoiced receivable’)
Cr Sales (again, still recognising the income earned as we have delivered the goods)
As long as we have delivered the goods we have ‘earned’ the income. It does not matter that we haven’t sent an invoice yet.
Accrued income is a current asset as we are likely to raise the invoice soon, and would sit on the balance sheet (the Statement of Financial Position) under trade receivables.
Eliminating accrued income
When you do raise an invoice for the goods that the customer has received you can eliminate the accrued income as follows:
Dr Sales ledger control account (now that you have raised an invoice that will be recorded in the sales day book)
Cr Accrued income (getting rid of our ‘un-invoiced receivable’ now that it has been invoiced)
Deferred income
Deferred income is the exact opposite of accrued income. It is when we receive payment from a customer for something that we haven’t done yet, so we haven’t actually ‘earned’ the income. It occurs in situations where a customer pays in advance for goods that we are going to deliver in the future.
As we haven’t ‘earned’ the income yet, we cannot recognise the sales income yet. Instead we recognise a liability called deferred income.
It may seem strange that we are recognising a liability when we are dealing with a customer but if they pay in advance for goods then we owe them that money until the point when we deliver the goods. If we fail to deliver we will have to repay them the amount that they have paid.
The double entry is therefore:
Dr Cash (the payment we have received in advance from the customer which will now be in our bank account)
Cr Deferred income (the liability we owe to the customer until we deliver their goods) Deferred income is a current liability and would sit on the balance sheet under trade payables.
Eliminating deferred income
When we deliver the goods to the customer, we have now done the work to ‘earn’ the income and will no longer have to potentially pay them back.
The double entry posted is:
Dr Deferred income (to remove the liability no longer needed)
Cr Sales (as we have now ‘earned’ the income)
Other forms of income
In some tasks the ‘income’ being dealt with may be something other than the sale of goods, for instance you may see rental income. The basic double entry here is much the same as above.
So, if a tenant has occupied some space that we own (meaning that we have ‘earned’ the income) but we haven’t yet invoiced them, this is accrued income:
Dr Accrued income
Cr Rental income (instead of sales)
If a tenant pays in advance for the next period, it is deferred income as we haven’t ‘earned’ the income yet:
Dr Cash
Cr Deferred income
• Gareth John is chief executive of First Intuition Cambridge