Accrued earnings are income or other revenue earned during a specified fiscal period but not received until the next or future fiscal periods. Most larger companies use the accrual method of accounting, meaning that earnings and expenses are entered into their books and records as income is earned and expenses are incurred. Most individual taxpayers must use the cash method of personal accounting. This means income is recorded as received and expenses are recorded when paid.
When a business generates earnings from its products or services, it may earn income in one month but not receive the cash until the next month. If the company closes its books each month, it generates accrued earnings, which it adds into its income in the month earned, even though the business cash balance does not increase in the current month from this revenue.
Businesses with investment accounts, such as mutual funds, receive income periodically, but this is still considered accrued earnings because its shared assets accumulate profits or declare dividends on a continuing basis. Most companies record this accrued income as they are notified of its existence. They then record the cash they receive, reducing their accrued earnings account shortly after recording the income. Other businesses may bypass recording investment accrued earnings and simply enter this income as it's received.
Understanding the way generally accepted accounting principles require companies to record earnings helps you make better evaluations of companies whose stock you may want to buy. The common entries are straightforward. Earned income generates a debit, or increase, to accrued earnings, or income receivable, and a credit, or increase, in income or earnings. As earnings are received, there is a debit to cash and a credit to the accrued earnings account.
Small companies who choose to -- or individuals who must -- use the cash accounting method do not have accrued earnings accounts. Since they only recognize income, revenue or other earnings as received, they have no need for accrued earnings accounts. The only similar account they may use is "loans payable." While they've received the cash proceeds, they also have written commitments to repay loans over a longer term than current periods.
Earnings may only include income from selling products or services. However, this term typically includes investment, bank interest, fee and miscellaneous income too sporadic to include in another specific earnings account. For example, a business that earns interest monthly on a bank account but only receives the interest quarterly, would have an accrued interest or interest income receivable account.
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