Income Received in Advance

Income Received in Advance

Income received in advance, also called unearned income, arises when a business receives cash for a service or use of an asset, but the earning period for that income falls partly or wholly in the next accounting period. The key idea is that income is recognised only when it is earned, not when cash is received. If the full amount received does not belong to the current year, the portion that belongs to the future is not treated as income of the current year — it is a liability instead.

Definition

The portion of income received during the current accounting period that belongs to the next accounting period is termed income received in advance or unearned income.

Accounting Treatment

The adjustment is made by recording the following journal entry:

Why this entry? The income account (say, Rent Received A/c) has a credit balance from the initial receipt. By debiting it, we reduce that balance to the amount actually earned in the current period. The credit to Income Received in Advance A/c creates a new liability account — because the business now owes the service (or the right to use the asset) for the future period.

Effect on Financial Statements

• The income account in the Profit & Loss Account will show only the amount earned during the current accounting period.
• The Income Received in Advance A/c appears as a current liability in the Balance Sheet, since it represents an obligation to provide the service in the future.

Worked Example

Ankit sublets part of his building to a fellow shopkeeper at ₹1,000 per month. On March 31, 2017, the shopkeeper pays rent in advance for the next three months — April, May, and June. The total amount received is ₹3,000. This amount was initially credited to the Profit & Loss Account (as Rent Received). However, since this income does not pertain to the current year ending March 31, 2017, it must be adjusted.

Adjustment entry:

After this entry, the Rent Received A/c will show a nil balance for the current year (since no rent was actually earned in the year ended March 31, 2017), and a new liability account — Rent Received in Advance — of ₹3,000 appears in the Balance Sheet.

Balance Sheet extract of Ankit as at March 31, 2017: