At a basic level, the concept of doing business is easy. You provide a product or service to a client who needs it in exchange for an agreed-upon price.
Depending on the nature of your business or the type of clients you deal with, the exchange may not be immediate. This means you'll perform the service or deliver the goods and wait for payment at a later date.
In essence, it counts as a sale, but the revenue is yet to reflect in your cash reserves or bank accounts. So, how do you address such revenue in your financial statements?
Fortunately, such circumstances have been accounted for under the Generally Accepted Accounting Principles(GAAP) as part of accrual accounting. In this article, you'll find the accrued revenue definition, learn how to record it, and see some examples.
What is accrued revenue?
Accrued revenue is earnings from providing a product or service, where payment has yet to be issued to the provider. Due to this, accrued revenue is recorded as a receivable owed by the customer for the business transaction.
For example, a SaaS company may acquire a customer who needs a service for the next six months. Under the contract terms, the business may agree to deliver the service at the price of $1,000 and send an invoice at the end of the month, which is payable on the 15th of the next month. From that point until the end of the contract, the SaaS company will have $1000 in accrued revenue from that particular customer.
When does accrued revenue occur?
You will only realize accrued revenue when there is a mismatch between the time of delivery of goods and services, and payment.
This can occur in instances such as:
- Long-term projects –This applies to the long-term projects where you'll book revenue in relation to the percentage of completion.
- Milestones – With large orders, you may have to complete bit by bit and book a certain amount of revenue based on the milestones you reach.
- Loans – If you loan money to other businesses or people, the interest income will qualify as accrued revenue. This is also known as interest revenue or accrued interest income.
Two main accrual accounting principles
When it comes to accrual accounting, two principles govern it. These are the Matching and Revenue recognition principles.
- Matching principle –You should record expenses and the revenue they help generate in the same accounting period when following this principle.
- Revenue recognition principle – Revenue is recorded in the same accounting period it is earned under the revenue recognition principle. Once you deliver the product or service, that revenue qualifies as earned.
How to record accrued revenue
As a SaaS company, you will likely encounter accrued revenue, especially if you also have a B2B model. Whereas it may seem complicated, recording accrued revenue is fairly straightforward if you have a basic understanding of bookkeeping and financial statements such as the balance sheet, trial balance, and income statement.
What you need to know about adjusting journal entries
With cash basis accounting, you'll debit accrued income on the balance sheet under the current assets as an adjusting journal entry. On the income statement, you'll record it as earned revenue.
When you receive the payment, record it in the revenue account as an adjusting entry. Doing this will only affect the balance sheet and not the income statement.
Accrued revenue criteria you need to keep in mind
When it comes to making an accrued revenue journal entry, there's one thing that you need to keep in mind at all times; each transaction will appear on the income statement as earned revenue and on the balance sheet as a current asset.
Аccrued revenue vs deferred revenue
Another concept similar to accrued revenue that you should be familiar with is deferred revenue. Such revenue occurs when a client pays you upfront for goods and services you are yet to deliver. Whereas accrued revenue is recognized before you receive the cash, deferred revenue is recognized after you receive the payment.
With accrued revenue and deferred, it's essential to know how they differ. Here are some distinctions to keep in mind:
- Deferred revenue can be spread over time, but an entry for accrued income occurs once for the whole amount.
- Since deferred revenue is unearned revenue, it is treated as a liability. On the other hand, accrued revenue is classified as an asset under the accounts receivable.
- Along with an accrued entry also comes the issuance of cash receipts. However, deferred revenue acts as recognition of payments and receipts after payment.
Accrued revenue examples
Understanding the theoretical aspect of accrued revenue is great. However, it will count for nothing if you cannot put it into practice. Here are some examples of accrued revenue to show you how to apply your knowledge in real-life business scenarios.
Suppose that company ABC comes into an agreement with customer Y to deliver 24 pieces of machinery in a year. Being a long-term project, company ABC can choose to recognize each machinery or set of machinery delivered as a milestone, for which they'll recognize the service revenue upon completion.
Regardless of whether company ABC will bill for the service after each milestone or at the end of the year, it will count as accrued revenue. However, in the books of accounts of client Y, the same will be recorded as accrued expenses.
Let's assume you run a consultancy agency for which you charge $20 per hour of consultation. In one project, a corporate client requests for 100 hours of consultations to be completed in four months. By the end of February, you have already offered 50 hours of consultation. However, you will only send the invoice worth $2,000 at the end of April upon completion of the project.
In your books of accounting, you'll record $500 as accrued revenue for January, February, March, and April. When you finally send the invoice, you'll convert it into the accounts receivable and then convert it into cash once the payment is made.
Accrued revenue FAQ
As you try to understand accrued revenue, it's understandable if some things are still unclear. As you learn more and put your knowledge into practice, everything will become clearer. In the meantime, here are the answers to some of the frequently asked questions about accrued revenue.
What is an accrued expense?
An accrued expense is a corporate finance term that refers to expenses that are recorded in accounting books before they have been paid. As the purchasing firm, you will record it when you incur the expenses and not when you pay them.
In essence, an accrued expense represents a company's obligation to make a cash payment in the future. Therefore, they are recorded as current liabilities in the balance sheet.
Is accrued revenue an asset?
Though accrued revenue represents revenue that you have earned but has not been paid for, it qualifies as an asset. However, it's important to note that it is not as valuable as cash as it requires more effort to bill and convert into cash.
Whereas accrued revenue may demonstrate a capacity to acquire customers, it shows that your collection process is inefficient if it's too high.
Is unearned revenue accrued revenue?
Though accrued revenue and unearned revenue are confusing to many, they couldn't be more different. Accrued revenue represents revenue that you have earned and for which you are yet to receive payment. Unearned revenue, also referred to as deferred revenue, refers to payments you have received for services you are yet to render.
Are accrued revenues on income statements?
To put it simply, yes. Once recognized, accrued revenue is recorded as revenue on the income statement. It is also recorded on the balance sheet under the accounts receivable.