It doesn’t matter when the sale is paid for, or when we send out the invoice. Sometimes we invoice in advance for the work being done. And sometimes we might do the work before issuing the invoice. In this article we explain the differences between accrued and deferred income and how we adjust the journal entries for them.
If we earn some income by delivering goods to a customer and the customer pays for those goods immediately, then the double entry is:
Dr Cash (the asset that we now own)
Cr Sales (the income that we have generated from delivering the goods)
This is a cash sale.
If we earn income by delivering goods to a customer and they do not pay immediately, this is often because we offer them a credit period. We would normally send them an invoice as a request for payment at a later date. The double entry for this is:
Dr Sales ledger control account (the asset of the receivables balance owed by the customer)
Cr Sales (we have still generated income by delivering the goods even if we haven’t been paid yet)
This is a credit sale. Note that it doesn’t matter that we haven’t been paid for the goods yet. We have delivered them to the customer so we have “earned’ the income. So the credit is still made to the sales account.
Now, what about if we deliver goods to a customer, who doesn’t pay immediately, but we haven’t issued an invoice yet? We still need to recognise the income earned as we have delivered the the goods. But because there is no sales invoice to list in the sales day book, there would be no entry made to the sales ledger control account. Therefore we need to recognise another form of receivable. This will be invoiced and collected at some point in the future; accrued income.
The double entry for this is:
Dr Accrued income (again, an asset. Think of this as an ‘un-invoiced receivable’)
Cr Sales (again, still recognising the income generated as we have delivered the goods)
As long as we have delivered the goods we have ‘earned’ the income. It does not matter that we haven’t sent an invoice yet.
Accrued income is a current asset and would sit on the balance sheet (the Statement of Financial Position) under trade receivables.
Eliminating accrued income
When you eventually raise the invoice for the goods that the customer has had you can eliminate the accrued income as follows:
Dr Sales ledger control account (now that you have raised an invoice)
Cr Accrued income (getting rid of our ‘uninvoiced receivable’ now that it has been invoiced)
Deferred income is the exact opposite to accrued income. This is when we receive payment by a customer for something, but haven’t actually earned the income (so we haven’t delivered the goods yet). It would occur in a situation where a customer is paying in advance for goods that we are going to deliver in the future.
If we haven’t delivered the goods yet then we haven’t ‘earned’ the income so we cannot recognise anything in the sales account yet. Instead we recognise a liability called deferred income. It may seem strange that we are recognising a liability when we are dealing with a customer but if they pay in advance for goods then we owe them that money until we deliver the goods. If we fail to do so we will have to repay them the amount that they have paid.
The double entry is therefore:
Dr Cash (the payment we have received in advance from the customer)
Cr Deferred income (the liability we owe to the customer until we deliver their goods)
Note that we don’t recognise anything in the sales account as although we have had some cash from the customer we haven’t done the work that ‘earns’ this income.
Deferred income is a current liability and would sit on the balance sheet under trade payables.
Eliminating deferred income
When we deliver the goods to the customer, we have now done the work to ‘earn’ the income and will no longer have to potentially pay them back so the double entry posted is:
Dr Deferred income (to remove the liability no longer needed)
Cr Sales (as we have now ‘earned’ the income)
Other forms of income
In some tasks the ‘income’ being dealt with may be something other than sales of goods, for instance it may be rental income. The basic double entry here is much the same as above.
So, if a tenant has occupied some space we own (meaning that we have ‘earned’ the income) but we haven’t yet invoiced them this is accrued income:
Dr Accrued income
Cr Rental income (instead of sales)
If a tenant pays in advance for the next period, it is deferred income as we haven’t ‘earned’ the income yet:
Cr Deferred income
We own a building in which we rent space to tenants at £1,000 per annum. One tenant pays for two years in advance and a second tenant will be invoiced for the same two years at the end of the second year. Show the relevant ledger accounts at the end of the first year.
Once you have had a go yourself, you can watch our solution here: