Accounting for accrued income
Accrued income is income that you have earned but not yet received. There are a few different types of accrued income you might need to deal with so this blog discusses why accounting for accrued income is necessary and how to do it.
Types of accrued income
The most common types of accrued income that a business might receive are:
- Interest income accrued on a loan
- Rent income accrued on a lease
- Service income accrued on a long-term contract
- Sales revenue accrued on goods sold on credit
- Other types of accrued income, such as dividends, royalties, and commissions
Why is accounting for accrued income important?
In the UK, all businesses with over £150K annual turnover must use accrual accounting rather than cash basis accounting which smaller business may use. This accounting principle requires businesses to recognise income at the time when it is earned, which may not be the same time as when the cash is received. Typically, if you offer your clients any form of credit period, you will need to be accounting for accrued income in your books.
How to account for accrued income
You’ll need to identify the different types of accrued income you receive and ensure that you are recognising the income in your books when you earn it. Let’s look at a couple of examples:
You provide office space for small businesses. You sign a contract with a tenant worth £300K over a twelve month period. You recognise the income earned each month, even though you only bill them once a quarter. The entries each month are:
- DR Accrued income £ 25K, CR Rental Income £25K.
- When you bill them at the end of the quarter, you CR Accrued income with £75K (3 months of accrued income) and DR Accounts receivable with £75k (the invoice amount) so your P&L doesn’t change.
You provide services to another company on a long-term contract worth £1.2m over 24 months. You must recognise the accrued income at the end of each accounting month, even though you will only be paid at the end of each year. The accounting entries each month are:
- DR Accrued income £50K, CR Service Income £50K.
- When you bill them at the end of the year, you CR Accrued income with £600K and DR Accounts receivable with £600K.
The same accounting principle applies to all your income that you earn. If you don’t immediately receive cash in the same accounting period, you must record accrued income as an asset on the balance sheet.
Best practices for accounting for accrued income
Accounting for accrued income is mandatory for companies operating accruals based accounting. Here are some of the ways you can ensure that you apply it correctly:
Identify all accrued income
This includes all income that has been earned but not yet received, such as interest income, rent income, service income, and sales revenue.
Measure accrued income accurately as possible
This may be relatively straightforward if the contract states the amount of income earned each period or you may have to estimate how much income relates to each accounting period based on historical trends if the income varies each month.
Record accrued income in a timely manner
As soon as the income is earned, it should be recorded in your accounts. This ensures your financial statements accurately reflect your business performance and financial position.
Review accrued income accounts regularly
Review your accrued income accounts regularly for accuracy and completeness. You may need to compare the accrued income accounts to invoices, contracts and other documentation.
Disclose accrued income in the financial statements
Include a schedule of accrued income in the notes to the financial statements.
Accounting for accrued income policy
Have a written policy or procedure in place for accounting for accrued income. This will help to ensure that accrued income is accounted for consistently and accurately.
Importance of accrued income
Having a clear picture of your accrued income offers some benefits.
Supports cashflow management
When running a business with insufficient liquid capital to operate, the board of directors might agree to take out a loan to cover the amount to be billed until the customer has paid. This helps manage the business’s cashflow.
Assists with more accurate budgeting and forecasting
Accrued income and expense accounting facilitates more accurate budgeting and financial planning by reporting all revenues and expenditures in the correct accounting period.
Gives greatly clarity for lenders and investors
Accruals accounting gives a more accurate picture of the businesses activity and the overall financial cashflow. This helps investors and lenders make better decisions about whether to lend to or invest in your company.
Are you correctly accounting for accrued income?
You may not have any choice about whether to account for accrued income. If your business is about to exceed £150,000 revenue per year and you are currently using cash basis accounting, you will need to switch to accruals based accounting. If you need help to figure out how to make the correct journal entries in your books and swap your bookkeeping onto an accruals basis, give the team at Adams Accountancy a call on 01322 250001 for a free chat.