What Is Income Received in Advance?
If a business has received a payment for a service that it has not rendered by the year-end, then this is considered income received in advance.
Income received in advance should be excluded from the year’s profit and loss account. In principle, this adjustment resembles an adjustment made for prepaid expenses.
Example: Adjusting Entries for Income Received in Advance
Mr. Jones is a property owner with several tenants. In 2019, he received cash for rent and credited it to his rent income account (income received in advance), amounting to $128,500.
This amount included a receipt of $6,200 (income received in advance). The tenant used this to pay for their rent for January 2020 in advance of December 2019.
The trial balance will, of course, show a credit balance on the rent income account of $128,500, but the fact is that the actual rental income for 2019 is only $122,300 ($128,500 – $6,200).
Another important fact is that on 31 December 2019, Mr. Jones has a liability toward his tenant to let him use his property in 2020. The value of the current liability is $6,200, the amount of rent received in advance. It should be shown on his balance sheet on 31 December 2019.
The trial balance on 31 December 2019 should, therefore, be adjusted as follows:
- To show that the actual rental income for 2019 is less than the credit balance disclosed by the trial balance
- To show that on 31 December 2019, there is a current liability on Mr. Jones’ part
The entry made in the journal to accommodate income received in advance is as follows:
- Dr.: Relevant income account
- Cr.: Advance income account (a newly opened account) with the amount of unearned income
In Mr. Jones’ case, the journal entry would be:
The effect of the above journal entry is twofold:
- When preparing the profit and loss account, rent income for the year would be shown at $122,300 ($128,500 – $6,200)
- When preparing the balance sheet, rent received in advance ($6,200) will be shown as a current liability
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