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Meaning of Income received in advance
It refers to an income received in advance by the entity for goods or services which have not been rendered in the current accounting period. The advance income received relates to the future accounting period. It is a personal account and presented on the liability side of the balance sheet.
Income received in advance includes;
1. Commission received in advance
2. Rent received in advance
3. Professional fees received in advance
4. Premium received in advance
Taxable or not?
Taxability of Income received in advance depends on the method of accounting (Accrual method or Cash method) followed by an entity.
So, let me help you understand the taxability considering both approaches with an example each.
1. Entity follows the accrual method
If the accrual system of accounting is followed then income received in advance will be not be taxed in the period of receipt. It will be taxed in the accounting period to which it relates.
In the month of December 20×1, Mr Michael received professional fees in advance 50,000 which relates to the month of January 20×2.
So, in this case, professional fees received in advance 50000 will not be taxed in the accounting period Jan-Dec 20×1. It will be taxed in the period Jan-Dec 20×2, as it belongs to January 20×2.
2. Entity follows cash method
If the cash system of accounting is followed then income received in advance will be taxed in the period of receipt itself.
Ms Alexa received the commission in advance 25,000 in the month of December 20×5, but the same relates to the month of January 20×6.
So, in this case, the commission received 25,000 will be taxed in the accounting period Jan-Dec 20×5 itself. Even though it relates to a future accounting period ie. Jan-Dec 20×6, it is of no concern here, as the cash system of accounting is followed.
We can conclude,
Method of accounting
Period of taxability
|Accrual method||Period to which advance income relates|
|Cash method||Period of receipt of advance income|