Various Types of Transactions – Collection from Other Source of Revenue and Income, Rental Income (Part 4c)

Rental income is earned by business entities for allowing another party to “use” the resources (assets) of the business entities. For example, letting of property, machinery, equipment & etc. An agreement is usually drafted and agreed by both parties. The terms agreed upon usually include the details or specifications of the assets, date of agreement, period, amount of rental e.g. per month. Many small businesses record rental income on cash basis, i.e. upon receipt. The double entry for recording rental income on cash basis is:-

Example

The financial period of ABC Co. Ltd. is from 1 January to 31 December. On 10 January 2006, XYZ Co. Ltd. agreed to rent Level 1 of a 3 levels shop owned by ABC Co. Ltd for 3 years commencing 1 March 2006 at $1,500 per month. 2 months rental and $500 utility deposit are collected by ABC Co. Ltd as security deposits. The following schedule shows the details of the money collected by ABC Co. Ltd. from XYZ Co. Ltd.:-

In the books of ABC Co. Ltd.

The rental recorded in the accounts for the year ended 31 December 006 under cash basis of accounting comprised the following:-

The double entries for the recording of the rental deposit, utility deposit and the 8 months rental collected (March ’06 to October ’06) during the year ended 31 December 2006 are:-

1. Rental deposit and security deposits

2. 8 months rental (March ’06 to October ’06)

3. Recognition November ’06 and December ’06 rental

The following adjustment is required to recognise the 2 months rental receivable (November ’06 and December ’06):-

The income statement and balance sheet of ABC Co. Ltd. before and after this adjustment for the recognition of 2 months rental are shown below to illustrate the impact of this adjustment:-

For the financial year ended 31 December 2007, ABC Co. Ltd. would have recorded the following rental collected during the year ended 31 December 2007: –

The double entry for the recording of these rentals received during the year ended 31 December 2007 is as follows:-

As the November 2006 and December 2006 rental collected should be recognised in the financial year ended 31 December 2006 and not 31 December 2007, the following correction journal adjustments are required:-

1. Correction of rentals incorrectly recognised during the financial year ended 31 December 2007

This journal entry is actually the same as the journal entry shown earlier to recognise the rental income in the financial year ended 31 December 2006. In the context of the financial statements of ABC Co. Ltd. for the year ended 31 December 2007, any adjustments made that affect the profit in earlier years, are now required to be adjusted to the retained profits brought forward.

2. Reversal of rental income incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007 and rental receivable

3. In addition, the rental of January 2008 collected on 3 November 2007 should only be recognised as rental income in the financial statements for the year ended 31 December 2008. The following correction journal adjustment is required:-

Reversal of January 2008 rental collected incorrectly recognised in the income statement of ABC Co. Ltd. for the year ended 31 December 2007

The income statement and balance sheet of ABC Co. Ltd. before and after adjustment No. 1, 2 & 3 are shown below to illustrate the impact of these adjustments: –

Note 1:

All adjustments affecting the income statements have to be repeated again and shown as adjustments to the retained profits account in the balance sheet. This is because all adjustments affecting any income statement items and the retained profits brought forward will eventually be included in the retained profits carried forward to the next financial year.