How to adjust for accrued and prepaid income

Step by step

1. Find income earned but unreceived. Identify amounts earned this period that have not yet been received. This is accrued income.
2. Add accrued income. Add it to the income figure and show it as a current asset, an amount owing to the business.
3. Find income received for later. Identify money received now that relates to a future period.
4. Deduct income in advance. Take it out of this period's income and show it as a current liability.
5. Enter the adjusted income. Only the income earned in the period reaches the income statement.

Worked example

Rent receivable of RM500 earned but not received is added to income and shown as a current asset.

Understanding the method

These are the mirror image of accruals and prepayments on the expense side. The income statement should show the income earned in the period, not just the cash that arrived.

Accrued income is income earned but not yet received. Income received in advance (also called prepaid income) is money received for a service not yet provided.

With accrued income, someone owes the business. So income in the income statement goes up, and a current asset appears in the statement of financial position.

With income received in advance, the business has the money but has not earned it. So income goes down, and a current liability appears, because the business owes the customer a service or a refund.

In short, accrued income adds to income and creates an asset. Income in advance cuts income and creates a liability. Each adjustment has an effect on both statements.

Common examples are rent receivable, commission receivable, interest on investments and fees earned. If rent of RM600 for the last month has not been received, that is accrued income.

If a tenant pays RM800 for two months and one month falls in the next financial year, RM400 is income received in advance. If the cash already includes an advance, work out the earned amount first and compare it with the cash.

Here is a worked case. A business sublets part of its premises for RM1,000 a month. Its year ends on 31 December.

The cash book shows RM11,000 received. Twelve months earned RM12,000, so the tenant still owes RM1,000.

The income statement shows rent receivable of RM12,000. The statement of financial position shows RM1,000 accrued income as a current asset.

Now change it. The cash received was RM13,000, because the tenant paid one month of the next year in advance.

Income earned is still RM12,000. The extra RM1,000 is a current liability, income received in advance.

To check, rebuild the earned figure from the rate and the time, then see where the difference from cash sits. If you are unsure of the direction, ask who owes whom.

An asset means someone owes you. A liability means you owe someone.

Common mistakes: putting the cash figure into the income statement with no adjustment, and adjusting the income but not the statement of financial position. Another is copying the expense-side habit and placing accrued income among liabilities (prepayments of expenses are assets, but prepaid income is a liability).

If accrued and prepaid income feel like the expense adjustments in reverse, we can help. One of our teachers can run through both with you side by side and test you on rent and commission questions. Book a trial class

Related skills

• How to record accruals and prepayments
• How to prepare an income statement for a sole trader
• How to prepare a statement of financial position

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.