Chapter 11
Accruals, Prepayments, Accrued and Deferred Income
#Accrual Accounting
Accrual accounting concerns the timing of the recognition of transactions. Under accrual accounting, the statement of profit or loss must include all income and expenses related to the period, regardless of the timing of cash receipts or payments.
The mismatches between the timing of transactions and their cash flow give rise to the following in the statement of financial position:
Key Point
Under accruals accounting, revenue and costs are both:
accrued (recognised as earned or incurred) and
recorded in the financial statements of the period they relate.
The matching concept requires expenses incurred in generating revenue to be matched against the revenue in determining profit or loss for the period.
Accruals accounting is applied to:
Trade Receivables and Trade Payables
When goods or services for resale are sold or bought on credit, the sale or the purchase is recorded immediately, and trade receivables and trade payables are created. As a result, the income (Sales) and expense (Purchases) is recognised even though there has been no actual payment.
Business Expenses and Income
The same logic used for credit sales and purchase transactions is applied to other expenses or income of the business, such as rental, electricity and insurance fees.
Example 1
Desmond owns a business that makes made-to-measure wooden window frames, doors and furniture. The business is known as DPQ Joinery, and all the wooden furniture is made at a single workshop premise that the business owns. Any painting required is done at a separate workshop space, which the business rents.
The office where all the accounting and administrative functions are carried out is attached to the business’s workshop premises.
DPQ Joinery would most likely incur numerous expenses to operate his business, such as wages, electricity, repairs, maintenance, telephone, insurance, rental of the painting workshop, advertising and stationery.
Broadly, expenses can be split into two categories:
·        Those related to a specific transaction on a particular date, for example, stationery.
·        Those related to an ongoing service received over time, for example, electricity, rent or telephone service.
For example, DPQ Joinery uses electricity daily, incurring an expense. However, the electricity supplier may only invoice DPQ Joinery each quarter for the electricity used over the past three months.
At DPQ Joinery’s year-end, the business will owe the electricity supplier for electricity used but not yet invoiced. This used but unpaid electricity will need to be accrued to ensure that the total cost of the electricity used in the year is reflected in the profit figure within the statement of profit or loss.
The business expense reflected in the final accounts should be based on the electricity use rather than how much has been invoiced or paid.
Electricity was used as an example, but the same logic applies to other business expenses with ongoing use – such as telephone service, rent or insurance.
#Accruals Accounting on Accruals, Prepayments, Accrued Income and Deferred Income
Payment received from income and made for expenses may be made in arrears (received/paid later) or in advance (received/paid earlier).
This chapter discusses accruals, prepayments, accrued income and deferred income. The journal entries below will only be made at the financial year-end.
Category
Explanation
Asset
Liability
Journal Entry
Accruals
Expenses incurred before invoice received/ payment made
✓
DR Expenses
CR Accruals
Prepayments
Invoice received/ payment made before Expenses incurred
DR Prepayments
CR Expenses
Accrued Income
Income earned before being invoiced/ payment received
DR Accrued Income
CR Income
Deferred Income
Invoiced/ payment received before Income earned
DR Income
CR Deferred Income
A business may incur expenses with payments/ invoices made in arrears or in advance:
Accruals are expenses invoiced/paid in arrears. For example, for a business with a year-end date of 31 January, electricity incurred from January to March is invoiced only at the end of March. In this example, the electricity accrual at the year-end will relate to the period 1 to 31 January. Accruals are reported as a liability in the statement of financial position and are a consequence of when the year-end date is.
Prepayments are expenses invoiced/paid in advance. For example, for a business with a year-end date of 31 December, the following year’s business insurance is invoiced once at the end of the current year e.g. 20X4. In this example, the insurance prepayment at the year-end 31 December 20X4 will relate to the following year-ending 31 December 20X5. Prepayments are reported as an asset in the statement of financial position and are a consequence of when the year-end date is.
A business may generate income with invoices issued/payments received in arrears or in advance:
Accrued Income is income generated for invoices issued/payments received in arrears. For example, a business with a year-end date of 31 July, may rent out additional space in an office and collect rental income at the end of the month. In this example, accrued rental income at the year-end will relate to the period 1 – 31 July. Accrued income is reported as an asset in the statement of financial position and is a consequence of when the year-end date is.
Deferred Income is income generated with invoices issued/ payments received in advance. For example, a business with a year-end date of 30 April, may collect rental income in advance for the following month. In this example, deferred rental income at the year-end, e.g. 30 April 20X4, will relate to the period 1 – 31 May 20X4. Deferred income is reported as a liability in the statement of financial position and is a consequence of when the year-end date is.
#What is an Accrual?
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An accrual is recognised when an expense incurred has not been paid or invoiced for by the end of the financial period.
Usually, a business recognises an expense when it receives a purchase invoice (credit purchase) or makes a payment (cash purchase); the journal entry would be DR Expenses, CR Payables/Bank.
However, certain ongoing expenses may only be invoiced after the services have been incurred. This is known as a payment in arrears. The expense that has yet to be invoiced at year-end is recognised as an accrual.
Example 2
DPQ Joinery’s electricity supplier sends its invoice every quarter (three months).
The quarterly invoice will be for the electricity used in the previous quarter (three months). This means that the electricity supplier will invoice DPQ Joinery after it has used the electricity. This is known as invoicing in arrears.
At the year-end, DPQ Joinery will owe the electricity supplier for electricity used since the last invoice date. A liability, therefore, needs to be recorded in the statement of financial position to reflect the amount owed.
This liability is an accrual, which will also be recorded in the electricity expense account.
#Accounting for Accruals
Once the accrual amount is established, the amount is recognised as an expense and a liability.
At year-end, the business will adjust for accruals creation for expenses incurred before receiving the invoice/making payment.
In the subsequent accounting period, where the business receives the invoice and makes the payment, it will reverse the accruals and account for the expense payment. The accruals creation and the reversal of accruals are posted to the relevant ledgers using journals.
The manual journal entry for creating accruals at year-end to recognise the expense incurred that has not been paid is:
General Ledger Account
DR
Individual expense
Expense
Expenses increased
CR
Accruals (liability) increased
The adjustment for accruals creation will have an impact on the business’s profits and net assets as follows:
Profits – The journal entry to create accruals is to debit the expenses account. Expenses increases, which will lead to a reduced profit figure.
Net assets – The corresponding entry is to credit the Accruals liability account. Net assets or capital is the assets less liabilities of a business. Since liability has increased, the net assets of the business will decrease.
In the next accounting period, the supplier will invoice the business for the expense, and the business will make payment. As a result, manual journal entries are made for:
the accruals reversal
the expense payment
The journal entry to reverse the accruals adjustment is:
Accruals (liability) decreased
Individual Expense
Expense decreased
The journal entry for the expense payment is:
Expense is recorded (increased)
Bank/ Payables
Bank (asset) decreased
Example 3
During the year ended 31 December 20X2, the electricity supplier sent the following invoices to DPQ Joinery, which were paid immediately:
Date
Period of electricity use
$
2 May
1 January to 30 April
8,460
2 August
1 May to 31 July
6,190
2 November
1 August to 31 October
7,230
21,880
DPQ Joinery paid a total of $21,880 for electricity during the year. However, this relates only to the electricity used by the business from 1 January to 31 October. An additional two months of electricity use (1 November to 31 December) have not been invoiced and paid.
At year-end 31st December 20X2, DPQ Joinery needs to adjust for Accrual creation.
There are two options to calculate the value of the Accrual:
Calculate the accrual amount based on the invoice for the same period last year (This will reflect consumption at the same time of year).
Calculate the accrual amount based on the last invoice received.
Note: Since there is no information on the last year’s invoice for the same period, DPQ Joinery will use the previous invoice received.
The last invoice received was $7,230 and relates to electricity use for August to October. However, we only need to make an accrual for two months (November and December) of electricity use.
From the last invoice,
The average cost for one month: $7,230 ÷ 3 months = $2,410
Therefore, two months’ worth of electricity: $2,410 × 2 months = $4,820
So, the estimated value of the accrual required to be created at year-end:Â $4,820
Electricity expense
$4,820
The debit to the expense account increases the expense for the year. As a result, this accrual adjustment will reduce profits during the year.
The impact of the accruals creation adjustment to the general ledger accounts for the year is as follows (assuming no opening balance in the Accruals account):
Accruals (liability)
31-Dec-X2
Electricity expense (expense)
02-May-X2
Bank
$8,460
31/12/X2
Statement of Profit or Loss
$26,700
02-Aug-X2
$6,190
02-Nov-X2
$7,230
In this example, we assumed there is no opening accrual on 1 January 20X2 for electricity expenses, meaning there is no accrual balance at 31 December 20X1.
This is slightly unrealistic because electricity expense is paid in arrears, and there should be an accrual balance at the end of each accounting period.
In this scenario, the closing accruals balance of $4,820 is the following period’s opening accruals balance.
Example 4 (with opening balance)
DPQ Joinery’s employees are paid on an hourly basis. The employees are paid once a week in arrears for hours worked in the previous week. The year-end is 31 December 20X2. At the end of the year, DPQ Joinery owes its employees a week’s worth of wages for the hours that they have worked.
During the year-ended 20X2, DPQ Joinery has the following information:
At the end of 20X1, DPQ Joinery owed its employees $1,560 for wages.
On 31 Dec 20X1, the manual journal entry is made to create an accrual.
Wages expense
$1,560
The accrual balance of $1,560 is brought forward in 20X2 as an opening balance. The expense is transferred to the profit or loss for the year and not brought forward to the following period.
DPQ Joinery paid $1,560 due to its employees on the first week of 20X2.
Since DPQ Joinery has paid its employees in the current financial period for opening accruals balance, we will reverse the accrual balance in 20X2 as DPQ Joinery no longer owes that balance to its employees. The expense payment of $1,560 is then recorded.
The accrual adjustment is reversed:
The payment of expenses is recorded:
In weeks 2 to 52 of 20X2, a further $84,934 of wages was paid to the employees.
The payment of expenses is recorded as follows:
$84,934
At the end of 20X2, the business owes its employees $1,790 for wages.
At the end of 20X2, DPQ Joinery creates an accrual for the balance owed to its employees who have not been paid.
$1,790
The impact of the accruals adjustment to the general ledger accounts is as follows:
Week 1
Wages Expense (2)
01-Jan-X2
Balance b/d (1)
Balance c/d
Wages expense (4)
$3,350
01-Jan-X3
Balance b/d
Wages expense account (expense)
Bank (2)
Accruals (2)
Week 2-25
Bank (3)
$86,724
Accruals (4)
$88,284
Bank account (asset)
Wages expense (2)
Wages expense (3)
Example 5
Anne owns a business with an accounting year-end of 30 September 20X5. A lease on office premises is taken on 1 January 20X5. Rent for the year to 31 December 20X5 is $2,400. On 1 January 20X5, $1,000 was paid regarding rent due.
For the year-ended 30 Sept 20X5 (Year 1):
The Year 1 financial period is from 1 October 20X4 to 30 Sept 20X5, while the lease rental period is from 1 Jan X5 to 31 Dec X5.
On 1 Jan X5, Anne paid rent of $1,000. The journal entry to record the expense payment is:
Rent expense
$1,000
At year-end 30 Sept X5, the portion of rental expense used but not paid is recognised as an accrual. The lease on office premises was taken from 1 Jan X5 to 31 Dec X5. On 30 Sept X5, Anne incurred 9 months of expense ($2,400 × 9/12 months) = $1,800.
Anne paid $1,000 at the start of the lease period; the total expense incurred but not paid is $800 ($1,800 − $1,000). The journal entry to create the accrual is:
$800
The ledger account during the financial year-end 30 Sept 20X5 will show the following after the journal entries have been recorded.
30-Sep-X5
Rental Expense (2)
01-Oct-X5
Rental (expense)
01-Jan-X5
Bank (1)
Profit or Loss
$1,800
Bank (asset)
Rental Expense (1)
For the year-ended 30 Sept 20X6 (Year 2):
The Year 2 financial period is from 1 October 20X5 to 30 Sept 20X6, while the rental lease period is from 1 Jan X6 to 31 Dec X6.
Anne pays rent on the office building lease of $1,400 on 31 Dec 20X5.
The journal entry to record the lease payment on 31 Dec X5 is:
$1,400
The rental for the lease for the first year would have been paid in total ($1,000 + $1,400) = $2,400. On 31 December 20X5, the accruals made of $800 in the previous year would have been incurred. The accruals adjustment will be reversed:
Anne has identified that the rent for the year to 31 December 20X6 is $2,800. On 15 June 20X6, she pays rent of $1,400.
The journal entry to account for the rental payment of $1,400 on 15 June X6 is:
At the year-end of 30 Sept X6, Anne will adjust for accruals for rental expenses incurred but not paid. The expense incurred for the year is $2,800 × 9/12 months = $2,100. Only $1,400 has been paid in respect of this expense. Therefore $700 ($2,100 − $1,400). The journal entry is:
$700
The ledger accounts during the financial year-end 30 Sept 20X6 will show the following after the journal entries have been recorded.
31-Dec-X5
Accrual Reversal (2)
Balance c/d (opening)
30-Sep-X6
$1,500
01-Oct-X6
15-June-X6
$2,700
$3,500
Rental Expense (3)
Activity 1
The accounting year end is 31 December 20X6. A gas bill for $300 arrives on 2 February 20X7 for the quarter to 31 January 20X7.
Show the 31 December 20X6 ledger entries for the accrued expense.
#What is a Prepayment?
A Prepayment is recognised when a business pays in the current financial period for an expense that relates to the next financial period.
A business recognises an expense when it receives an invoice and makes payment. However, certain expenses may be invoiced and paid before they are incurred. This is known as a payment in advance. The amount paid for expenses not yet incurred is recognised as a prepayment.
Example 6
DPQ Joinery rents a workshop and pays rent quarterly in advance. This means payment must be made on the first day of each rental period. This payment is for the rental expense for the next three months.
The business started renting this workshop on 1 June 20X2. So far, the following invoices for rent have been received and paid:
Period invoice relates to
1 June
1 June 20X2 to 31 August 20X2
1,200
1 September
1 September 20X2 to 30 November 20X2
1 December
1 December 20X2 to 28 Februray 20X3
3,600
In 20X2, a total of $3,600 is paid for rent covering the period from 1 June 20X2 to 28 February 20X3. Some of this payment relates to 20X3, so if the total amount of $3,600 were included as the rent expense for 20X2, then it would be overstated.
In this situation, you need to reduce the expense. This reduction to the expense is known as a prepayment.
Example 7
The accounting year-end is 30 June. Insurance on the business property runs from 1 October to 30 September and is paid annually in advance.
Paid:
1 October 20X5
$1,200
1 October 20X6
What is the insurance expense for the year ended 30 June 20X7?
Consider the timeline:
The expense for the accounting period under consideration must include all the amounts which accrue to (belong in) the year to 30 June 20X7:
July X6 to September X6
(3/12 × $1,200)
$300
October X6 to June X7
(9/12 × $1,800)
$1,350
Expense in profit or loss
$1,650
Note:Â Because $1,800 was paid in advance, there will be a prepayment of $450 on 30 June 20X7. This is recognised as a current asset, increasing net assets/capital in the statement of financial position and profit (by reducing the expense).
Accounting for Prepayments
During the year, the business makes payments/ receives invoices for expenses not yet incurred and records expense payments. At year-end, the business identifies which payments were made for expenses not yet incurred. Since expenses are not incurred in the year, an adjustment for prepayment creation is made (credits/reduces expenses).
When the business continues using the expenses in the next accounting period, it will adjust for prepayment reversal.
In a financial year, a supplier sends invoices to the business, and the business makes payments for the expenses. However, at year-end, it is identified that the amount paid does not relate to expenses incurred during the year. Therefore, a prepayment is recognised to reduce the expense charge for the year.
During the year, two entries occur for payments of expenses not yet incurred:
recording the expense
creating the prepaymentÂ
The journal entry for the expense booking is:
Expense increased
Bank/Payables
Bank decreased
The above journal entry reflects the business paying the expense in cash to the supplier.
(Note – it doesn’t matter whether the invoice from the supplier has been paid or not. The important thing is that an expense has been recognised in the system that relates to a future period).
The manual journal entry for prepayment creation is:
Prepayment
Prepayment (Asset) increased
Expense is reduced
Since expenses have been recognised earlier, although they have not yet been incurred (only incurred in the next accounting period), a prepayment is created to reduce the expense charge during the year.
The adjustment for prepayment creation will have an impact on the business’s profits and net assets as follows:
• Profits – The journal entry to create a prepayment is to credit the expenses account. Expenses decrease, which will lead to an increased profit figure.
Net Assets – the corresponding entry is to debit the Prepayment account. Net assets or capital is the assets less liabilities of a business. Since assets have increased, the business’s net assets will also increase.
In the next accounting period, the business incurs expenses as the period progresses. Therefore, the business records the reversal of the prepayment made in the previous period. Thus, the Prepayment account is reversed, and the expense is recorded.
The manual journal entry for the reversal of the prepayment is:
Expenses have increased
Prepayment (asset) decreased
Example 8
DPQ Joinery pays rent for one of its shops quarterly in advance. This means payment is made on the first day of each rental period. DPQ Joinery has a current year-end of 31st December 20X2.
DPQ Joinery started renting on 1 June 20X2. So far, the business has received and paid the following invoices in respect of rent:
1 Sept
1 Dec
1 December 20X2 to 28 February 20X3
In 20X2, DPQ Joinery paid $3,600 for rent covering the period 1 June 20X2 to 28 February 20X3. Some of this payment relates to the financial period 20X3 and should not be included as the rent expense for 20X2 to avoid overstatement.
DPQ Joinery will adjust for prepayment creation on 31 December 20X2 for the two months’ rent advanced payment relating to 20X3 (January and February). The last invoice received and paid of $1,200 relates to three months’ rent for December, January and February. Therefore, the rent for January and February is prepaid.
The average cost per month for the last invoice: $1,200 ÷ 3 months = $400
Therefore, two months’ worth of rental: $400 × 2 months = $800
The value of the prepayment required at the end of the year is $800
The supplier invoices the business for the expense not yet incurred, and the business makes a payment of $1,200 on 1 December 20X2. The journal entry for the expense payment is as follows:
Rent expense account
Bank account
At the year-end, the business has identified that only $400 relates to expenses during the year. It will reduce the expense charge and recognise it as an asset under prepayments. The journal entry to create the prepayment is:
The prepayment (asset) creation reduces the expense amount. Thus, it increases profit for the year by reducing losses.
The impact of the prepayment creation adjustment to the general ledger accounts should look like this (assume no opening balance in the prepayment account):
Prepayments (assets)
Rent Expense (2)
Rent expense account (expense)
01-June-X2
Bank (during year)
Prepayments (2)
01-Sept-X2
Bal c/d
$2,800
01-Dec-X2
$3,600
31-Dec X2
To profit or loss
The expense in the statement of profit or loss is correct. The monthly rent is $400, and DPQ Joinery has rented the shop for seven months (from June to December). Therefore, the correct rent expense is $400 × 7 = $2,800.
Example 9 (with opening balance)
DPQ Joinery pays insurance for his business once a year on 1 September. The payment on that date provides insurance coverage from 1 September until 31 August the following year. On 1st September 20X2, DPQ Joinery paid $4,875 for insurance. DPQ Joinery has a current year-end of 31st December 20X2.
The prepayment at the start of the year was $2,880. This is based on the 20X1 payment of $4,320 for insurance, for which DPQ Joinery has prepaid eight months out of the twelve (8 × $4,320) ÷ 12 = $2,880
The journal entry for each transaction is:
At the end of 20X1 (the previous year), DPQ Joinery prepaid insurance expenses of $2,880. A journal entry was made to create a prepayment.
$2,880
Insurance expense
The prepayment of $2,880 is brought forward in 20X2 as an opening balance.
By the end of August 20X2, DPQ Joinery would have incurred the prepaid expenses of $2,880.
Since DPQ Joinery has incurred the prepaid expenses of $2,880 by August 20X2, the opening prepaid balance from 20X1 is reversed, and expenses are finally recognised.
On 1st September 20X2, DPQ Joinery pays $4,875 for insurance expenses covering 1 September X2 to 31 August X3. The payment of expenses is recorded as follows:
$4,875
At the end of 20X2, DPQ Joinery notes that not all $4,875 relates to the financial period 20X2. A prepayment is created for the payment made for expenses not yet incurred.
$4,875 was paid for insurance cover from 1st Sept 20X2 to 31st August 20X3. Out of the 12 months, 8 months (January 20X3 to August 20X3) do not relate to the financial period 31 Dec 20X2.
Therefore, $4,875 × 8/12 months = $3,250 is recognised as prepayment.
$3,250
The impact of the prepayment creation on the general ledger accounts is as follows:
Prepayment (assets)
31-Aug-X2
Insurance expense (2)
Insurance expense (4)
$6,130
Insurance (expense)
Prepayment (2)
Prepayment (4)
Bal b/d
$4,505
$7,755
Bank (assets)
Insurance expense (3)
Activity 2
During the year ended 30 June 20X5, a business pays $5,905 for electricity to cover the opening accrual of $590 and the invoices received during the year. The last invoice was $1,860 and covered the period from 1 March 20X5 until 31 May 20X5.
What should the expense be in the Statement of Profit or Loss for the year ended 30 June 20X5?
During the year ended 30 September 20X7, a business paid $10,200 for insurance to cover the period from 1 July 20X7 to 30 June 20X8. The opening prepayment for insurance expenses was $6,850.
What should the expense be in the Statement of Profit or Loss for the year ended 30 September 20X7?
#What is Accrued and Deferred Income?
Accrued income is recognised when a business receives/invoices its income in arrears after earning it. At year-end, the business has earned income that has not been received.
Deferred income is recognised when a business receives/invoices its income before earning it. At year-end, the business received a payment related to the following year.
Accruals and prepayments are liabilities and assets recognised during year-end due to payment of expenses in arrears or in advance.
Accrued and deferred (prepaid) incomes are assets and liabilities recognised during year-end due to income receipts in arrears or in advance.
Accrued income is recognised as an asset to reflect the income owed to the business since revenue has been provided but invoice/payment has not yet been issued/ received. (receipt in arrears).
Deferred income is recognised as a liability as payment has been received for revenue not yet provided. (receipt in advance)
#Accounting for Accrued Income
At year-end, the business will adjust for accrued income creation for income generated for payments in arrears.
The journal entry for the accrued income is:
Accrued income
Accrued income (asset) increased
Revenue/ income
Income
Income has increased
The income calculated for the current financial year where payment has not been received is recognised as an asset (accrued income).
The adjustment for accrued income will have an impact on the business’s profits and net assets as follows:
Profits – The journal entry to create accrued income is to credit the income account. Income increases, which will lead to an increased profit figure.
Net assets – The corresponding entry is to debit the accrued income asset account. Net assets or capital is the assets less liabilities of a business. Since assets have increased, the net assets of the business will increase.
In the next financial period where payment has been received, the business will reverse the accrued income adjustment made in the previous period and record the income receipt.
Reversal of accrued income:
Income has decreased
Accrued income account
Accrued income (asset) decreased
Record of Income Receipt:
Bank (Asset) increased
Individual Income Account
#Accounting for Deferred Income
At year-end, the business will adjust for deferred/prepaid income for income generated for payments in advance.
Payment has been received in the current financial period for income generated in the following financial period. The business records the income receipt during the year, then calculates and creates the deferred income amount adjustment.
Record of income receipt:
Bank (asset) increased
The journal entry for deferred income creation is:
Deferred income
Deferred income (liability) increased
The adjustment for deferred income will have an impact on the business’s profits and net assets as follows:
Profits – The journal entry to create deferred income is to debit the income account. Income decreases, which will lead to a decreased profit figure.
Net assets – The corresponding entry is to credit the deferred income liability account. Net assets or capital is the assets less liabilities of a business. Since liabilities have increased, the net assets of the business will decrease.
As the months progress, the business will generate income in the following accounting period. Accordingly, it will record deferred income reversal.
The journal entry for the reversal of deferred income is:
Deferred Income (Liability) decreased
Example 10
DAHS Co rents out two properties that it owns. Its year-end is 30 June 20X6. Payment for both properties is made every three months (every quarter).
For property 1, the rent is received in advance. The rent is $5,400 per quarter, and the last receipt was for the three months of 1 May to 31 July 20X6.
For property 2, the rent received is in arrears. The rent is $3,600 per quarter, and the last receipt was for the three months of 1 February to 30 April 20X6.
Property 1
Property 2
Rent Receipt:
In advance
In arrears
Rental per quarter:
$5,400
Period where payment already received:
1 May 20X6 to 31 July 20X6
1 Feb 20X6 to 30 April 20X6
1 month payment (July X6) relates to the following period
2 months income (May & June) has not received payment
Recognition:
Deferred Income (Liability)
$5,400 × 1/3 = $1,800
Accrued Income (Asset)
$3,600 × 2/3 = $2,400
Journal entry in 20X6
Income receipt:
DR Bank account $5,400
CR Rent income $5,400
No receipt in 20X6
Deferred/ Accrued Income:
DR Rent income $1,800
CR Deferred income $1,800
DR Accrued income $2,400
CR Rent income $2,400
Journal entry in 20X7
Reversal of Accrued/ Deferred Income:
DR Deferred income $1,800
CR Rent income $1,800
DR Rent income $2,400
CR Accrued income $2,400
Income Receipt:
Already received in 20X6
DR Bank account $3,600
CR Rent income $3,600
Effect on 20X6 Financial Statement:
Deferred income reduces income and, therefore, reduces profits in the year. In addition, since deferred income is recorded as a liability, the capital amount is reduced.
Accrued income increases income in the year and, therefore, increases profits. Accrued income is recorded as an asset. This causes the capital amount to increase.
