What is Prepaid income? – Journal Entry and example

We will explain the meaning and journal entry for Prepaid income with the help of both rules of accounting i.e. golden rules and modern rules of accounting in this article as below:

What is Prepaid income?

Prepaid income means that income that is received but not earned yet. It is also known as Pre received Income. In other words, the income received by the company before providing services to the other company or individual.

Examples:

• Rent received for let-out building in advance 
• Commission Received in advance 
• Interest received in advance
• and any other income which is received in advance

Why do we need to maintain a Prepaid Income account?

According to the rule and principle of the accounting, incomes or expenses are recorded in the books of that financial year in which actual it has earned or due respectively. So, That’s why we have to create an account of accrued income.

Journal entry for Prepaid income with the golden rule.

The journal entry for prepaid income with the help of golden rules of accounting are explained in the following example: 

1. Example of Journal entry for creating prepaid income with the golden rule:

On 01/08/2020, rent of Rs. 5,000/- per month received for the period of one year in advance.

Solution: 

According to the above transaction the Rent received for the period of one year from the date of 01/08/2020. So, it means Rent is received up to 31/07/2021. (From 01/08/2020 to the end of one year) 

But the current financial year in which the rent is received will end on 31/03/2021.

So, after the last date of the financial year, the amount of rent will be treated as advance rent for the current year because it is related to the next year.

So, from 01/04/2021 to 31/07/2021(4 months) the amount of rent received will be treated as advance rent received.

The total amount of Adance rent received From 1/4/2021 to 31/07/2021 = 

Number of Months * Rent per month

= 4*5000

= 20,000/-

The balance amount of rent will be treated as rent received for the current year from 01/08/2020 to 31/03/2021 (8 months)

The total amount of rent received From 01/08/2020 to 31/03/2021 =

Number of Months * Rent per month

= 8*5000

= 40,000/-

So in this transaction, we will treat three accounts with the golden rules of accounting shown as following.

1. Cash a/c -> Asset A/c -> Real Rule  -> Cash Comes in -> Debit
2. Rent received A/c -> Income A/c -> Nominal Rule -> Rent Earned -> Credit
3. Advance Rent received A/c -> Representative personal A/c -> Personal Rule -> Tenant paying cash, giver  -> Credit

The journal entry for the transaction is the following:

Download an image for a ready reckoned:

2. Example of Journal entry for adjustment of advance rent received in the next year:

On 01/04/2021, The advance rent received in the previous year adjusts to the current year Rs 20,000. 

Solution: 

So in this transaction, we will treat two accounts with the golden rules of accounting shown as following.

1. Rent received A/c -> Income A/c -> Nominal Rule -> Rent Earned -> Credit
2. Advance Rent received A/c -> Representative personal A/c -> Personal Rule -> Tenant receiving Benefits, Receiver-> Debit

The journal entry for the transaction is the following:

Journal entry for Prepaid income with Modern rule.

The journal entry for prepaid income with the help of modern rules of accounting are explained in the following example: 

1. Example of Journal entry for creating prepaid income with the modern rules:

On 01/08/2020, rent of Rs. 5,000/- per month received for the period of one year in advance.

So in this transaction, we will treat three accounts with the modern rules of accounting shown as following.

1. Cash a/c -> Asset A/c -> Assets Rule  -> Increase in Asset -> Debit
2. Rent received A/c -> Income A/c -> income Rule -> increase in income -> Credit
3. Advance Rent received A/c -> Liability a/c-> Liability Rule -> Increase in Liability  -> Credit

The journal entry for the transaction is the following:

Download an image for a ready reckoned:

2. Example of Journal entry for adjustment of advance rent received in the next year:

On 01/04/2021, The advance rent received in the previous year adjusts to the current year Rs 20,000. 

Solution: 

So in this transaction, we will treat two accounts with the golden rules of accounting shown as following.

1. Rent received A/c -> Income A/c -> income Rule -> increase in income -> Credit
2. Advance Rent received A/c -> Liability a/c-> Liability Rule -> Decrease in Liability  -> Debit

The journal entry for the transaction is the following:

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