Key Concepts
Based on the accrual basis of accounting, income is recorded when it is earned — when the goods or services have been provided — regardless of when cash is received.
Income received in advance arises when a business receives cash before the income has been earned. The amount received is held back — it only becomes income in the period when the goods or services are provided.
Income received in advance is a current liability — the business has been paid for goods or services it has not yet provided, so it still owes the customer those goods or services.
The account name follows the type of income — [Income type] received in advance (e.g., Service fee revenue received in advance, Rental income received in advance).
Income received in advance = received but not yet earned = current liability.
- Year-end (Adjustment): Dr [Income type] / Cr [Income type] received in advance
- If omitted: income overstated → profit overstated
- First day of next period (Reversal): Dr [Income type] received in advance / Cr [Income type]
Step-by-Step Approach
Step 1 — Record the full receipt as income when cash is received:
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| [Date] | Cash at bank (+ current asset) | X | |
| [Income type] (+ income) | X |
Step 2 — Year-end: Set aside the part not yet earned
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 31 Dec | [Income type] (− income) | X | |
| [Income type] received in advance (+ current liability) | X |
Step 3 — Start of next financial period: Reverse the set-aside amount back into income
Why reverse? The service is now being provided this year, so the income set aside last year is finally earned — it goes back into income.
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 1 Jan | [Income type] received in advance (− current liability) | X | |
| [Income type] (+ income) | X |
Effects If Adjustment Not Made
If the year-end adjustment (Step 2) is not made:
- Income is overstated → Profit is overstated
- [Income type] received in advance is not recorded → current liability is understated
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 20X5 | |||
| 1 Feb | Cash at bank (+ current asset) | 6,000 | |
| Service fee revenue (+ income) | 6,000 |
Lay the subscription on a timeline and mark where the year end falls:
1 Feb 20X5 31 Dec 20X5 31 Jan 20X6
|————— 11 months earned ——————|—— 1 month ——|
| (Feb–Dec: service given) | not yet given
By 31 December 20X5, Bytes & Brains has provided 11 months of service (Feb–Dec). One month (January 20X6) remains undelivered.
Unearned amount = $6,000 × 1/12 = $500
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 20X5 | |||
| 31 Dec | Service fee revenue (− income) | 500 | |
| Service fee revenue received in advance (+ current liability) | 500 |
Why reverse? In 20X6 the business provides that last month of service, so the $500 set aside last year is now earned — it goes back into income.
| Date | Particulars | Dr ($) | Cr ($) |
|---|---|---|---|
| 20X6 | |||
| 1 Jan | Service fee revenue received in advance (− current liability) | 500 | |
| Service fee revenue (+ income) | 500 |
Effects if Step 2 (Adjustment) is not made:
- Service fee revenue overstated by $500 → Profit overstated by $500
- Service fee revenue received in advance (current liability) understated by $500
Statement of Financial Position (extract)
| $ | |
|---|---|
| Current liabilities | |
| Service fee revenue received in advance | 500 |
Classifying income received in advance as a current asset — It is a current liability because the business still owes the customer a service.
Counting the wrong number of months — Count only the months that fall after the financial year end — these are the months not yet earned. Don't count the months that have already passed.
Omitting the reversal at the start of the next financial period — The reversal must be dated the first day of the next period (e.g., 1 January 20X6).