What is income received in advance?
If a business has already received a payment for a service, which it has not rendered by the year-end, then such an income received in advance and should be excluded from that year’s Profit & Loss Account. This adjustment resembles, in principle, to prepaid expense adjustment.
Example (Adjusting Entries for Income received in advance)
For example, Mr. John has some properties, which he has let out to several tenants. During 2019, he received in cash and credited to his Rent Income Account(income received in advance), rents totaling $128,500. This amount includes a receipt of $6,200 (income received in advance), which is in respect of January 2020 rent paid by a tenant in advance in December 2019. The Trial Balance will, of course, show a credit balance on 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. John has a liability towards his tenant to let him use his property in 2020. The value of this current liability is $6,200, the amount of rent received in advance, which should be shown in his Balance Sheet on 31 December 2019.
His 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 exists a current liability on Mr. John’s part.
The journal entry required to accommodate incomes received in advance is:
Dr.: The Relevant Income Account
Cr.: Advance Incomes account (a newly opened account) with the amount of unearned income.
In Mr. John’s case the journal entry would be:
The effect of the above journal entry would be two folds:
When preparing the Profit and Loss Account, Rent Income for the year would be shown at $122,300 ($128,500 – 6,200), and
When preparing the Balance Sheet, Rent Received in Advance, $6,200 will be shown as a current liability.