A question we see coming up, in particular during these difficult times, is how should accrued income from rent be treated? In this article we will have a look at the accounting entries and discuss some of the income tax consequences.
What is Accrued Rent Income?
We have a few articles going into accrued revenue in a broader sense, in particular our article here. However, in this article we are focusing on accrued rent income – obviously from the landlords point-of-view. This area is of particular interest to my wife and I as we have a small flat we rent out.
Accrued income more generally is the bringing to account, or recognition, of income you have earned but have not yet received payment for. In a normal “cash accounting” system revenue is recognised when it is received – which normally means when it is earned, as the two events take place at the same time.
Rental Example – Cash v Accrued Income
Under the the cash basis of accounting when you receive your monthly rental payment from your tenants, the following accounting entry would be made in your business accounting records:
But under accrual accounting we recognise the movement of economic benefits and obligations, rather than when cash moves. This is a fancy way of saying we want to track when there are changes in assets (things you own) and liabilities (things you owe). The accounting conceptual frameworks developed over the last 20 or so years have moved away from a focus on the income statement to that on the balance sheet (but don’t worry about that for the moment).
So under an accrual system, if the the tenants paid the rent when it was due the journal entry would be same; we would record the increase in cash at bank and rental revenue. But what happens if you don’t receive the rent when it’s due? Under an accrual system you initially make the following entry:
|10 May||Rental Debtors||$750|||
So we would record the revenue due but we would record the increase in assets through debtors (money you are owed) rather than cash at bank (as you haven’t received it yet). When your tenants pay you would then make the following accounting entry:
|10 May||Cash at Bank||$750|||
What About Income Tax?
This of course varies across tax jurisdictions, but western countries tend to follow a similar approach. Generally, business tax payers have the choice of submitting tax records on a cash basis or accrual basis. And often these are based on certain income thresholds. So for example, because our rental business is very small we use the cash basis for our income tax reporting. So we report to the tax office the income less expenses we have received and paid respectively. Not whether the income or expenses have been incurred, but whether we have received the money or paid it out.
Obviously the cash system is simpler and in the end its just timing differences. This means that the income and expenses eventually all get recorded, it’s just the timing of them under a cash or accrual system.
In this simple example we have ignored the issue of debtor default and how that would be treated. If this is something you would like written about please let us know. We hope you have found this article useful and have a better understanding of how income from accrued rent should be accounted.