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Understanding Accrued Income & It's Accounting Treatment

Understanding Accrued Income Accounting Treatment of Accrued Income

Cash Basis of Accounting System:

Cash Basis of Accounting is a system of writing books of accounts in which only cash transactions are recorded. This implies that in cash basis of accounting, revenue or expenditure is recorded only when cash is received / paid for the respective transactions. This system is generally used only by small traders who do not require to get their books of accounts audited. In this system, expenses are recorded only when cash is paid; similarly, revenues are recorded only when cash is received.

Accrual Basis of accounting system:

Accrual Basis of accounting is a method of book keeping where revenues are recorded as soon as they are earned. Similarly, expenses are recorded as soon as they are incurred. Hence, any expense or income must be recognized in the books of accounts as soon as it becomes due and not at the time when cash is paid / received. In this blog we are going to focus on the concept of Accrued Income as per accrual basis of accounting. Accrual Basis of Accounting system is strongly recommended by US GAAP as well as IFRS. Hence, all businesses who require to get their books of accounts audited must follow this system of accounting.

Accrued Income:

In Accrual basis of accounting, an accrued income is an income which has already been ‘Earned’ but not received by the business. Hence, an accrued Income is a current asset for any business. It may happen that certain items of income such as interest on investment, commission, rent, etc are earned during the current accounting year but have not been actually received by the end of the same year. Such incomes are known as Accrued Income.

Accounting Treatment of Accrued Income:

Under the accrual basis of accounting, accrued income is recorded with an adjustment entry prior to issuing financial statements. Hence, accrued income will have an impact on P&L A/c as well as Balance Sheet. There will need to be an adjustment entry that debits Accrued Income A/c (Current Asset – a balance sheet account), and credits Income A/c (an income statement account). Hence, the amount of accrued income will be added to the related income in profit and loss account and new account of accrued income will appear on asset side of balance sheet.

Adjustment entry for accrued income is:

Date Particulars LF Debit Credit
Date on which income is due... Accrued Income A/c        Dr. *****
To Concerned Income A/c *****

 

Example:

Accrued Interest: Mehta Associates invests in 7.35% bank FD for one year on 1st January 2018. The financial year for the firm ends on 31st March 2018. At the time of closing the books of accounts, the firm must have earned interest for one quarter i.e. from 1st Jan to 31st March, 2018. The remaining amount will be earned on the first three quarters of the next financial year. Hence, the interest earned in the first quarter that falls in current financial year, will be recorded in the books of accounts as Accrued Interest.

Adjustment Entry for Accrued Interest:

Date Particulars LF Debit Credit
31/03/2018 Accrued Interest A/c        Dr. *****
To Interest on FC A/c *****

Effect of Accrued Income on P&L and Balance Sheet:

Accrued Interest is a current asset for any business. Hence, it will appear on the asset side of the balance sheet. Interest on FD is an indirect income for the firm, hence it will appear on credit side of Income Statement.

Income Statement of Mehta Associates for the year ended March 31, 2018

Dr

Expenses/Losses

Amount (Rs.) Revenues/Galns

Cr.

Amount (Rs.)

Interest on FD ******

 

Balance Sheet of Mehta Associates as on March 31, 2018

Dr

Expenses/Losses

Amount (Rs.) Revenues/Galns

Cr.

Amount (Rs.)

Accrued Interest ******

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