What is Accrued Income?
Definition: Accrued income is a sum of money earned but yet to be delivered to the person or company who earned it. It is an accounting concept that refers to a situation where a gain has taken place, but it is not yet in the hands of the recipient. Thus, it is recorded as a receivable on the books.
Accrued income refers to amounts that have been earned, but the amounts have not yet been received. For example, a corporation may have its excess cash invested in an investment security that pays interest every six months. Between the interest payment dates, the company will have:
- Accrued interest income that is to be reported on the income statement.
- Accrued interest receivable that is to be reported on the balance sheet.
Accrued income is earnings from investments that have not yet been received by the investing entity, and to which the investing entity is entitled. This concept is used under the accrual basis of accounting, where income can be earned even when the related cash has not yet been received. Under the accrual basis, the investing entity should accrue its best estimate of the income in the accounting period in which it earns the income. It may not be necessary to generate this accrual if the amount is immaterial, since the resulting accrual would have no demonstrable impact on the financial statements.
What Does Accrued Income Mean?
This kind of income occurs commonly in financial instruments that have certain payment cycles. For example, a bond that has a biannual coupon can be accrued on a monthly basis but the actual money earned will be delivered at the end of each cycle. This accrued income serves as an estimation of the pending earnings yet to be received and it is considered an asset for the bondholder. The value of the bond in that case will be its actual market value plus any accrued income yet to be paid.
This is particularly important for companies, since they normally produce monthly financial statements for management purposes and in order to portrait an accurate financial position accountants must estimate the accrued income of the financial instruments owned by the company. An accrued income account will be recorded as an asset and it will be offset by the subsequent delivery of the income, therefore the asset is gradually converted into revenue, interest or dividends earned.
Mutual funds or other pooled assets that accumulate income over a period of time but only pay out to shareholders once a year are by definition accruing their income. Individual companies can also accrue income without actually receiving it, which is the basis of the accrual accounting system.
Most companies use accrual accounting. It is the alternative to a cash accounting method, and it is necessary for companies that sell products or provide services to customers on credit. Under the U.S. generally accepted accounting principles (GAAP), accrual accounting is based on the revenue recognition principle that seeks to match revenues to the period in which they were earned, rather than the period in which cash is received. In other words, just because money has not yet been received does not mean that revenue has not been earned.
The matching principle requires that revenue be recognized in the same period as the expenses that were incurred in earning that revenue. Also referred to as accrued revenue, accrued income is often used in the service industry or cases in which customers are charged an hourly rate for work that has been completed but will be billed in a future accounting period. Accrued income is listed in the asset section of the balance sheet because it represents a future benefit to the company in the form of a future cash payout.
In 2014, the Financial Accounting Standards Board (which establishes regulations for U.S. businesses and non-profits) introduced Accounting Standards Code Topic 606 Revenue From Contracts With Customers, to provide an industry-neutral revenue recognition model to increase financial statement comparability across companies and industries. Public companies had to apply the new revenue recognition rules for quarterly reports starting in Q1 2018 and for the calendar year ending December 31, 2018.
What Accounting Method is Used For Accrued Income?
Individual investors aren’t the only ones that can earn accrued income. Companies and other investing entities also receive them. Accrual accounting is an accounting method used by companies when they handle accrued income. The accrued income is recorded on an income statement, regardless of whether the company received it or not. The company’s accountant will record the revenue as interest receivable in the accounting book.
Accountants record accrued income is recorded as an asset (from which debits are made) in the balance sheet. On the other hand, they record accrued expenses as a liability.
When is Accrual Accounting Used?
Under the United States’ accounting principles, accrual accounting is used at any point revenue is earned but not received. Revenue is recognized as earned at the time an individual or business creates a contract, regardless of the time it will be received. Therefore, if you sell an item to a customer in January on credit and the person is supposed to pay in February, you will record the revenue from the sale in January, not February. If you are the seller, the income which you have yet to receive will be called accrued revenue.
How to Handle Accrued Income and Accrued Expense
Assume another scenario. In this case, you produce and distribute bathing soap. A customer placed an order for a dozen units of the soap. They placed the order on July 28th. A dozen units of soap were shipped on July 30th but will be delivered to the customer on August 6th. The order is not prepaid, so the customer will pay only after the goods are delivered.
The delivery agent will also earn a commission from you if the items are delivered successfully. The Generally Accepted Accounting Principles, or GAAP, dictates that you will record the revenue from the soap sale as income in July, even though you’ll be paid in August. Also, the commission which the delivery agent will earn is recorded as an accrued expense.
So, the rule is that revenue should be recognized at the time it is made, even though you haven’t received payment. On the same note, expenses are recognized between companies and individuals at the time they are made, even though you haven’t paid out the money.
Let’s say Company A is starting its operations in January 1 and it has $25,000 of capital available that will be invested in different financial instruments. In January 2, the company decided to invest $10,000 in bonds that pay a 5% interest rate in quarterly payments. The company bought these bonds at $12,500 and this means they will receive a quarterly amount of $500. The payment cycle starts at January 1 and payments occur each 90 days after that (a quarter).
At the end of April (two months before the 2nd payment cycle) the company’s management required a financial statement and the accountant had to accrue the income earned through this financial instrument during the first month of this cycle. This income hasn’t been received but it has been earned already. After performing the calculations, the accrued income at the end of April was $41,67.
Accrued Income Reported on the Balance Sheet
The amount of accrued income that a corporation has a right to receive as of the date of the balance sheet will be reported in the current asset section of the balance sheet. It could be described as accrued receivables or accrued income.
The amount of the accrued income reported on the income statement also causes an increase in a corporation’s retained earnings, which is part of the stockholders’ equity section of the balance sheet.
- Accrued income is revenue that’s been earned, but has yet to be received.
- Both individuals and companies can receive accrued income.
- Although it is not yet in hand, accrued income is recorded on the books when it is earned, according to accrual accounting methods.
Frequently Asked Questions
What is accrued income?
Accrued income is a term used in accounting to describe income that has been earned, but not yet received. The returns on your investment are “accrued” because you are entitled to the earnings.
Why is it important to record accrued income?
Recording accrued income is important because it allows companies and individuals to track their income more accurately. This information is important for budgeting and cash flow projections. Also, if a company or individual decides to terminate a contract early, they will still have to pay for the services or goods that were already provided.
How is accrued income recorded in accounting?
Accrued income is recorded as receivables in the Accounts Receivable (AR) section of the Balance Sheet to reflect the money that is owed to the company or individual. It is also recorded as income in the Revenue section of the Income Statement.
Is accrued income a current asset?
Accrued income is a current asset because it is owed to the company or individual in the near future.
What are examples of accrued income?
Examples of accrued income can include wages earned but not yet paid, rent earned but not yet paid, and interest earned on a bond but not yet received.