5. The Accrual Principle and Income

Question 1

Explain deferred income.

Is it an asset or a liability?

Answer 1

Cash may be received in one period although the actual sale to which it relates occurs in the subsequent period.

An example is a deposit (or advance payment, or payment on account) received from a customer on an item which will be delivered in the future.

The deposit is banked but until the actual sale is recognised, the cash should be treated as still being owing to the customer, not as income. This is known as deferred income, a current liability in the statement of financial position.

Question 2

Explain accrued income.

Is it an asset or liability?

Answer 2

Cash may be received in one period in relation to an event which arose in a previous period. An example is where a supplier makes a refund in relation to a purchase in a previous period. This is known as accrued income, a current asset on the statement of financial position.

Question 3

What is the accounting treatment for deferred income and accrued income? (3)

Answer 3

1) Calculate the amount of the deferred or accrued income.
2) At the end of the reporting period, prepare a journal entry which updates the relevant statement of profit or loss accounts, and which sets up the relevant asset and liability accounts.
3) At the beginning of the next reporting period, reverse the journal entry.

Question 4

Explain the issue that clubs or associations often face.

What is the accounting treatment? (3)

Answer 4

Clubs or associations do not generally maintain a receivables ledger so just use cash accounting. Clubs and associations are likely to use a manual system of accounting.
Some members pay an annual subscription earlier than they need to (in advance), and other pay late (in arrears). At the end of the year there are bound to be amounts in arrears and amounts paid in advance, but the club will nevertheless need to make sure that the income figure it shows relates only to the actual reporting period.

The treatment is as follows:
1. Open a subscriptions receivables ledger account.
2. Enter all amounts you know e.g. annual income or cash received.
3. Calculate the balancing figure (in an exam, the balancing figure will be the amount you are looking for)