Accrued Income

Accrued Income: Exploring its role in financial reporting and investment analysis.
Accrued Income
3 min
02-Apr-2024

Financial analysis is one of the best ways to determine whether a company is investable or not. It not only gives you information about its current financial situation but also provides insights into its future growth potential. Among the many metrics you need to thoroughly analyse is accrued income. It is a crucial financial concept that directly impacts the financial statements and overall financial health of a company.

But what exactly is it, and how do companies account for it in their financial statements? In this article, we will delve into what accrued income is, its treatment in accounting and how it differs from deferred income.

What is accrued income

Accrued income is a term that is used to represent the revenue a company has earned but has not yet received in cash or cash equivalents. It indicates the earnings that have been recognised before their actual receipt.

Accrued income is essentially a result of the time lag between the delivery of goods or services and the receipt of cash. Since it signifies cash flows that a company would receive in the future, it is recognised as a current asset and is recorded on the balance sheet as such.

The primary reason why companies choose to recognise accrued income is due to the accrual system of accounting. Most companies in India follow this system, where both expenses and income are recognised as and when they are incurred and not when they are paid or received. This is in contrast to the cash system of accounting, where expenses and income are recognised only when they are paid and received respectively.

What are the advantages of accrued income

One of the major advantages of recognising accrued income is that it provides a more accurate representation of the company's financial situation. The concept works on the logic that just because a business has not yet received payment for its goods and services does not mean that it has not earned it. And since it has earned the income, it must be recognised in its financial statements.

Additionally, it also promotes transparency since it provides the company’s stakeholders with details of the income that the company is owed. Furthermore, accrued income also enables companies to better manage their cash flow and financial situation.

How is accrued income treated in accounting

Now that you have seen the meaning of accrued income, let us try to understand how it is accounted for in the financial statements.

In accounting, accrued income is recorded on the income statement as revenue, even though cash has not been received. Simultaneously, it is also recognised as a current asset on the balance sheet under the heading ‘accounts receivable’.

As and when the income is actually received, necessary adjustments are made to ensure that the accrued income reflects the exact amount that is owed to the company. The adjustment is done by reducing accrued income by the amount received and crediting the cash and bank accounts of the company.

How is accrued income different from deferred income

The meaning of accrued income is vastly different from that of deferred income. Understanding the difference between the two can help you make informed decisions when analysing a company.

As you know by now, accrued income represents revenue that the company has earned but not received.

Deferred income, meanwhile, represents revenue that the company has received but not yet earned. For example, if a customer pays for a subscription service upfront for an entire year, the revenue would be recognised as deferred income by the company offering the said service. In other words, deferred income is a company receiving cash in advance for goods or services that it will provide in the future.

Unlike accrued income, deferred income is recognised as a current liability in a company's balance sheet despite being recorded as revenue in its income statement.

Examples of accrued income

Let us now look at a few hypothetical examples of accrued income to gain a better understanding of the concept.

  • Income from services
    A company that generates revenue by rendering services first and then receiving payment for them later is one of the most common examples of accrued income. Here is an example.
    Imagine a consulting firm providing interior design services to a client. The firm provides the services in the month of November but generates an invoice for them only in December. Despite raising the invoice a month after providing the service, the company will still record the revenue in November as accrued income. The fact that the revenue was earned in November does not change, even though the company has not yet invoiced for it.
  • Credit sales
    A company that has generated revenue by selling goods to its customers on credit but has yet to generate an invoice or receive payment for such sales is another classic example of accrued income.
    Assume that there is a company that sells 1,000 critical engine parts to a car manufacturer each month on credit. The invoice for such sales, however, is only generated on a bimonthly basis. In this case, the revenue from the sale of 1,000 engine parts is recognised each month as accrued income, even if the invoice is yet to be generated.
  • Interest and rent income
    The loan interest that accrues each month but is yet to be received is also considered to be accrued income in the financial statements of the company that provided the loan. Similarly, the rent income from a leased property is also recognised as accrued income by the landlord, even if the tenant fails to make the payment by the end of the month.

Conclusion

Accurate recognition of accrued income is crucial to ensuring that the financial statements reflect the true picture of a company’s performance. In addition to recognising it, companies must also ensure that their accrued income is adjusted as and when they receive the payments. Failure to make timely adjustments could lead to errors and a misrepresentation of the company’s finances.

As an investor, when analysing a company's various financial statements, you must pay attention to how the company has recognised its accrued income. Additionally, you should also try to assess whether appropriate adjustments have been made to account for the payments received by the company.

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