Is Income a debit or credit?

Do we debit or credit income? Why do we account for income that way, and do the rules change if we receive income in advance?

Anyone who has ever studied accounting has probably wondered about these questions one time or another. Learning the rules of debit and credit can be quite a challenge when you’re just starting out. Once you learn the basic principles that are explained in this article, I’m sure you will find accounting for income much easier.

Income is always credited. Credit entry is made to an income account unless the income is unearned, in which case the credit entry is recorded in a liability account.

Income is recorded as a credit because it increases the owners’ equity, which appears on the credit side of the accounting equation.

Income that is earned by a business is recorded in the accounting books by crediting the relevant income account, such as the revenue account. 

Example 1

Jane sells clothes and accessories at her shop.

After much bargaining, a customer purchased a shirt from Jane for $20, paying her in cash.

The revenue received on cash sale is an earned income of the business. Jane will record the transaction by passing the following accounting entries:

  • Debit Asset Account         Cash in hand       $20
  • Credit Income Account    Sales Revenue     $20

Accrued Income

Income is recorded according to the accruals basis of accounting. This means that we credit the income account as soon as the business earns income rather than waiting for the cash inflow.

Business is said to have earned its income when either one of the following applies:

  • It has delivered its product to a customer.
  • It has provided a service to a client.
  • Its resources have been used by another person that entitles the business to receive rent, dividends, or interest based on the duration of use.

Example 2

Lynda is a painter who commissions portraits and landscapes.

Last week, her friend Mike ordered a portrait of himself with his dog Pluto. Lynda finished the painting over the weekend and dispatched this masterpiece to her friend’s address.

Lynda charged $500 for the painting, which her friend promised to pay from his next month’s salary. 

Lynda should immediately record the income now by passing the following accounting entries in her books.

  • Debit Asset Account         Receivable from Mike          $500
  • Credit Income Account    Income from commissions $500
When Mike pays Lynda, she will cancel the receivable as follows:

  • Debit Asset Account     Cash in hand                 $500
  • Credit Asset Account    Receivable from Mike   $500

Unearned Income

Any income received by a business in advance of delivering a product or service is treated as unearned income.

For example, if a business receives rent on its leased property in advance, it will be treated as unearned income until the period for which the rent was paid has lapsed.

Unearned income is not credited to an income account until it is earned. It is recorded instead by crediting a liability account to acknowledge the fact that the business has an obligation to deliver something in return for the advance. 

Example 3

Lilly is a fashion designer.

Donna has placed an order with Lilly for designing a dress for her wedding. She has quoted $5000 for the dress, $2000 of which is payable in advance. Donna has deposited the advance in Lilly’s business account. 

The remaining payment will be made in cash when Donna collects the dress from Lilly’s studio.

The advance represents an unearned income for Lilly who should recognize it as a liability by passing the following accounting entries:

  •  Debit Asset Account         Cash at bank              $2000
  • Credit Liability Account    Customer advances   $2000
When Donna collects the dress, Lilly will cancel the liability and record the income in full:

  • Debit Liability Account    Customer advances   $2000
  • Debit Asset Account        Cash in hand              $3000
  • Credit Income Account   Sales revenue             $5000

Quiz

How much do you know about income accounting?

Take the free below quiz and find out!

 

   Instructions for solving quiz:

  • Click on one of the given options that you think is correct.
  • If you are not sure about a question, review the lesson above.
  • Mark yourself out of 7 by rewarding 1 mark for each correct answer.

   Good luck!

Question 1

Income is always  ________________  .

Debited

Wrong answer.

 

Credited

You're right!

 

Income is never debited.

Question 2

Increase in revenue has the effect of  _____________ owners equity.

Increasing

Correct!

 

Increase in revenue is added to the retained earnings which is part of the owners equity.

Decreasing

Incorrect.

 

Question 3

When income is earned from a cash sale, ________________  will be debited.

Revenue

Incorrect.

Assets

Spot on!

 

Cash sale is recorded by debiting cash in hand (assets) and crediting revenue (income).

Equity

Wrong answer.

Question 4

Betty is a florist. She received an order for supplying 100 bouquets of flowers for her friend Sara’s wedding next month. Sara paid Betty in advance, the entire amount of the order in cash.

a) What accounting entries should Betty record for the advance revenue?   

     Debit Account

Cash

(asset)

Correct!

Revenue

(income)

Wrong answer.

Customer

Advances

(liability)

Incorrect.

    Credit Account

Cash

(asset)

Incorrect.

Revenue

(income)

Incorrect.

Customer

Advances

(liability)

You're right!

 

Unearned income should be recognized as a liability in the balance sheet until it is earned.

Next month…

 Sara weds Jamie

b) What accounting entries would Betty record after she delivers the flowers to Sara’s wedding?

 Debit Account

Cash

(asset)

Incorrect.

Revenue

(income)

Incorrect.

Customer

Advances

(liability)

Correct!

 

This cancels the liability that Betty had recorded previously. Because the income is now earned, there is no need to keep it as a liability in the accounting books.

    Credit Account

Cash

(asset)

Incorrect.

Revenue

(income)

Exactly!

 

Since the income from Sara's order is now earned, Betty can show it as such in the income statement. 

Customer

Advances

(liability)

Incorrect.

How many questions did you answer correctly?

Score              Grade

7                      Master

6                        Pro 

4+                     Pass

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