Accrued Income: Income that has been earned or accumulated but not yet invoiced and/or received.
Accrued Income Details
You can apply the concept of accrued income for both individuals and companies. For individuals, you might accumulate your earnings from investing in a financial opportunity—like stocks or bonds—before actually receive the money for it. For companies, accrued income is the direct result of accrual accounting.
Accrual accounting is an accounting method indicating a company’s financial position by acknowledging transactions as they happen rather than waiting for a cash exchange to take place. To put it simply, even if a customer pays for goods or services in credit, the company could still record the transaction as real revenue—since the money would have been received eventually. Just because the company has not yet received real cash doesn’t mean that income has not been earned.
The accrual accounting method is popular among modern companies, especially for industries that typically sell in credit. In fact, many corporations believe that accrued accounting can give a more accurate picture of a business’s performance. Current cash flows are combined with future cash flows so that revenue will better match the costs needed to regularly run the business. Accrual accounting is the direct opposite of cash accounting, which only recognizes transactions when cash exchanges are confirmed.
Example of Accrued Income
Let’s say that you're a landlord who owns a student apartment building and you're renting out rooms. Because most of the students receive financial aid to pay for their housing, your due date for rent isn't until the beginning of the second month of the semester to make sure everyone has time to receive it. But the students are still allowed to move in on the first day of their lease if they've signed a contract. You would want to adopt the accrual accounting method to record your revenues earned.
Instead of waiting to record your income until the second month, you would still record your earnings as the legally binding contracts were signed because they guarantee that payment. You would want to add them to your total annual budget, split evenly between the months of the year. This will secure a steady stream of income every month to better match the costs of running and maintaining the apartment building.
Another simple example is when an employee works for a company. Alan is a full-time professor for XYZ University. For his work during this month, Alan will only receive payment at the beginning of next month. In other words, Alan has accumulated earnings over time and should receive the appropriate amount of cash during the appointed payment period. This can also be considered as accrued income.
Types of Accrued Income
In real life, several financial investments can fit the definition of accrued income— some parties accumulate revenue overtime before receiving it. One instance is mutual funds.
A mutual fund is a financial vehicle that collects money from different investors to buy market securities (e.g. stocks) by a management firm. When someone signs up for a mutual fund, they're expected to receive a regular stream of revenue over time, but will only receive actual cash about once a year. Putting it another way, shareholders have accumulated earnings over the year, but would only receive money at the end of the period.
Significance of Accrued Income
Accrued income is undoubtedly important for companies adopting the accrual accounting method. For companies mostly offering goods or services in credit, they won't receive cash immediately when a transaction happens.
If they use cash accounting instead of accrual accounting for recording entries, the revenues earned won’t match the expenses to run the company since the income will only be recorded when cash is received. This will give a relatively inaccurate picture of the company’s real condition.
For companies selling in credit, even if the payment hasn't been collected yet, the company will likely—if not definitely—receive it at some point. In addition to accrued income, accrual accounting also requires the company to record accrued expenses. An accrued expense is any expense that's incurred before it's paid, like a mechanic purchasing a part on a line of credit. Using accrual accounting, companies can more easily manage their resources and expenses for future projects.