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Ajay Mady

Why is income received in advance treated as a current liability?

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1 Answer

  1. This answer was edited.

    In simple words, income received in advance is treated as a current liability because the income that has been received by the company before its due date, is not yet earned and the company is obliged to deliver the purchased goods or services in the future. Assume that you have received an amount from a customer, for the goods or services that you will provide in the future, therefore, in the current financial period it is a liability for your company. It can be referred to as Deferred revenue, Deferred income, or Unearned income.

    Example

    XYZ Ltd. has received 40,000 from a customer in March for goods that will be delivered in April.

    XYZ Ltd. will debit the Cash a/c for 40,000 and credit the Deferred Revenue a/c for 40,000. On the 31st of March, the balance sheet of XYZ Ltd. shall include 40,000 in the cash of their company and record the deferred revenue of 40,000 under current liabilities.

    The journal entries to be recorded are as follows:

    MarchCash a/c Debit40,000Debit the increase in asset
     To Deferred Revenue a/cCredit40,000Credit the increase in liability

    (being income received in advance)

    AprilDeferred Revenue a/cDebit40,000Debit the decrease in liability
      To Sales Revenue a/cCredit40,000Credit the increase in revenue

    (being  goods sold to the customer)

    Placement in the balance sheet

    (Extract of the balance sheet)

    balance sheet

    Hope this helps.

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