The use of accruals and deferrals in accounting ensures that income and expenditure is allocated to the correct accounting period. The adjusting journal entries for accruals and deferrals will always be between an income statement account (revenue or expense) and a balance sheet account (asset or liability).
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. You can read more about double entries in our double entry overview article.
What is double entry for immediate payment?
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.
What is double entry for credit orders?
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: 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. Therefore, the credit is still made to the sales account.
Accrued income
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 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.
What is double entry for accrued payment?
- 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.
How do you eliminate 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
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.
What is double entry for deferred income?
- 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: We don’t recognise anything in the sales account as though we have had some cash from the customer. The reason for this is that we haven’t yet done the work that ‘earns’ this income.
Deferred income is a current liability and would sit on the balance sheet under trade payables.
How do you eliminate 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:
- Dr Cash
- Cr Deferred income
Your turn
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:
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FAQs
Accrual: Accrual revenue is revenue that is earned, but has not yet been received (such as accounts payable). Deferral: Deferred revenue is revenue that is received, but not yet incurred (such as a deposit or pre-payment).
Which answer best describe accruals and deferrals? ›
Accruals occur when the exchange of cash follows the delivery of goods or services (accrued expense & accounts receivable). Deferrals occur when the exchange of cash precedes the delivery of goods and services (prepaid expense & deferred revenue).
How do you pass entry for deferred revenue? ›
Recording deferred revenue means creating a debit to your assets and credit to your liabilities. As deferred revenue is recognized, it debits the deferred revenue account and credits your income statement.
Can accrued revenues and deferred expenses be illegal? ›
YES, IF THE ACCRUED REVENUES AND DEFERRED EXPENSES ARE NOT RECORDED UNDER THE RECOGNITION PRINCIPLES AND GAAP PRINCIPLES, THEN IT IS ILLEGAL.
What is an example of accrual and deferral? ›
Understanding Accrual vs Deferral Methods
For example, if a company delivers $10,000 worth of goods in December but is not paid until January, the $10,000 is recognized as revenue for December. Meanwhile, deferral accounting involves postponing the recognition of revenue or expenses until a later period.
What is an example of accrued income? ›
An example is when customers purchase goods on account or pay for a service on account. The term “on account” means that customers make the purchase on credit. In such situations, companies recognize that they are selling goods or performing a service even when they haven't received any cash.
What are accruals and deferrals for dummies? ›
Revenue: Accrual revenue refers to the revenue the company earns but hasn't received. Conversely, deferred revenue refers to the revenue the company receives but hasn't yet incurred.
What is the difference between accrued income and accrued expenses? ›
Accrued revenues are revenues that are earned in one accounting period, but cash is not received until another accounting period. Accrued expenses are expenses that have been incurred in one accounting period but won't be paid until another accounting period.
What is the difference between deferred revenue and accrued expenses? ›
Deferred revenue is the portion of a company's revenue that has not been earned, but cash has been collected from customers in the form of prepayment. Accrued expenses are the expenses of a company that have been incurred but not yet paid.
How to calculate deferred income? ›
Identify the goods or services in question. Subtract the direct costs associated with providing the goods or services from the total amount received to calculate the revenue to be deferred. Record the deferred revenue on the balance sheet as a liability.
Accounting for Deferred Revenue
Since deferred revenues are not considered revenue until they are earned, they are not reported on the income statement. Instead they are reported on the balance sheet as a liability. As the income is earned, the liability is decreased and recognized as income.
How to journal deferred income? ›
You need to make a deferred revenue journal entry. When you receive the money, you will debit it to your cash account because the amount of cash your business has increased. And, you will credit your deferred revenue account because the amount of deferred revenue is increasing.
What could go wrong with deferred revenue? ›
The payment is considered a liability to the company because there's a possibility that the good or service may not be delivered or the buyer might cancel the order. The company would have to repay the customer in either case unless other payment terms were explicitly stated in a signed contract.
Can you reverse accrued revenue? ›
When an accrual is made, it is just a placeholder for the actual entry that will come later. When the actual entry is made, the accrual must be reversed. An accrual reversal is called a reversing entry and it will zero out the previously accrued amount, usually at the beginning of the next accounting period.
Is it ethical to accrue revenue and deferred expenses? ›
Yes, this practice is ethical. Accrual of revenue is necessary if services are already performed, yet cash was not yet received. Deferral of expenses is appropriate whenever there were advance payments made for a particular service that was not yet performed.
What is the difference between accrued expense and deferred income? ›
Deferred revenue is the portion of a company's revenue that has not been earned, but cash has been collected from customers in the form of prepayment. Accrued expenses are the expenses of a company that have been incurred but not yet paid.
What is the difference between accrued income and unearned income? ›
Accrued revenue represents revenue that you have earned and for which you are yet to receive payment. Unearned revenue, also referred to as deferred revenue, refers to payments you have received for services you are yet to render.
What is the meaning of deferred income? ›
Deferred income is also known as deferred revenue or unearned income. As the name suggests, it refers to income that you have received or not earned yet. Usually, this is because a customer or client has made an advance payment for services that have not yet been rendered or goods that have not yet been delivered.
Is accrued income an asset or expense? ›
Accrued revenue is recognized as an asset on the balance sheet, because it represents revenue that has been earned but not yet received. Since the company has provided goods or services associated with the revenue, its obligation is met, which means it can count the revenue as an asset, rather than a liability.
