Prepaid income is revenue received in advance but which is not yet earned.
Income must be recorded in the accounting period in which it is earned. Therefore, prepaid income must be not be shown as income in the accounting period in which it is received but instead it must be presented as such in the subsequent accounting periods in which the services or obligations in respect of the prepaid income have been performed.
Entity should therefore recognize a liability in respect of income it has received in advance until such time as the obligations or services that are due on its part in relation to the prepaid income have been performed. Following accounting entry is required to account for the prepaid income:
|
Debit |
Cash/Bank |
|
|
Credit |
Prepaid Income (Liability) |
|
Example
ABC LTD receives advance rent from its tenant of $10,000 on 31st December 2010 in respect of office rent for the following year. ABC LTD has an accounting year end of 31st December 2010.
ABC LTD will recognize a liability of $10,000 in the financial statements of year 2010 in respect of the prepaid income to acknowledge its obligation to make the office space available to the tenant in the following year. Following accounting entry will be recorded in the books of ABC LTD in the year 2010:
|
Debit |
Cash/Bank |
$10,000 |
|
Credit |
Prepaid Rent Income (Liability) |
$10,000 |
The prepaid income will be recognized as income in the next accounting period to which the rental income relates. Following accounting entry will be recorded in the year 2011:
|
Debit |
Prepaid Rent Income (Liability) |
$10,000 |
|
Credit |
Rent Income (Income Statement) |
$10,000 |