When it comes to accounting, the timing of when revenue is recognized can be very important in keeping your finances accurate. It is of importance in the way financial reporting is prepared and is especially so because of the accrual accounting method that many businesses follow. A means of recognizing money into an organization when it has been earned — not simply received. Accrued revenue allows companies to get a clearer picture of their finances and accurately predict cash flows for the future. Firms that provide recurring services or are engaged in projects that last for multiple years and receive payment in the future find the idea especially useful.
What is Accrued Revenue?
Accrued revenue is income that a company has earned but hasn’t yet received payment for. This means that with the accrual accounting rule, businesses record their sales when they sell something even if they do not receive payment yet. For example, if a company offers service in June but the customer pays in July, the firm will account for revenue as of June. When the payment is eventually received, accrued revenue becomes actual revenue and would be reflected on the balance sheet under current assets. It makes sure that company financials truly represent the aspects of financial performance over a certain range.
Don’t Get Confused In The Type
You must have encountered the following two types of revenues in accounting: accrued revenue and deferred revenue. Both play an important role in that respect, as they aid in making appropriate financial statement reporting of the performance of a company over time.
Accrued Revenue
Revenue already earned but not yet billable nor collected. It arises when the goods or service has already been delivered and the time to collect such an amount can soon be expected in the future. It allows accounting earnings to be accounted for on as early an occurrence as possible, matching the concept of the matching principle.
Deferred Revenue
Deferred revenue refers to payment received before a company delivers goods or services. It is a liability on a balance sheet for a company because the company owes either a product or a service to a customer. It becomes actual earned revenue only at the time of the company providing the fulfillment.
A difference between the two revenues will help businesses understand the actual earnings recorded over time. Accrued revenue means money that is soon to be received, while on the other hand, there is deferred revenue which means money received but not yet earned.
Accrual Accounting and Its Two Principles
Accrued revenue operates on the principle of accrual accounting. This system is quite different from cash accounting, which records revenue simply when it receives the payment. There are two fundamental principles followed in accrual accounting:
Revenue recognition principle
This rule stipulates that revenue should be recorded based on income earned, regardless of cash flow. For instance, in accrued revenue, income would be raised anytime a product is delivered or a service provided, not when cash was made.
Matching Principle
According to the matching principle, all expenses should be matched with revenues generated with their help in the same period. This principle helps a company’s financial statements portray its profitability truly and accurately. In the case of revenues that are accrued in value, expenses incurred to generate that revenue must be recognized in the same period, even if cash has not yet been received.
These two principles together ensure that firms record transactions in the period they occur, hence providing an even better picture of a company’s financial health.
When Does Accrued Revenue Arise?
Accrued revenue arises when providing services or goods over an extended period of time or for an extended period of time, particularly when payments are delayed. Let’s understand this with some examples:
Long-term projects
construction or engineering firms often bill clients on several stages of completing a project. Although the work is still in progress, their earned revenues allow them to recognize income for the percentage of work completed prior to issuance of the last invoice.
Subscription Services
Companies whose core businesses provide subscription services, such as software or content providers, receive payment when the service is delivered, but they only receive installments of payments. Accrued revenue allows such companies to record revenues for that period.
Interest Income
Most banks and financial institutions earn interest incomes on loans or investments before the borrowers or investors make payment.
In such instances, accrued revenue helps businesses to report revenues generated from work or services provided, no matter that the payment will be received at a future date.
How is Accrued Revenue recorded in a Journal?
Accrued revenue is adjusted entries recorded into a company’s accounting journals. This is how it is done:
- Original Entry – Recognition of Accrued Revenue:
Debit: Accounts Receivable (accrual that the customer owes)
Credit: Accrued Revenue or Service Revenue (to recognize revenue)
This journal entry increases both assets (Accounts Receivable) and revenue, exactly showing the amount of revenue earned during the period.
- When Received Cash
Debit- Cash or Bank-off to recognize receipt of cash
Credit- Accounts Receivable-off to remove a receivable now that the payment has been received
In this step, cash is increased along with the reduction of accounts receivable such that the financial statement exposes the actual cash flow after the accrued revenue is collected.
Why is Accrued Revenue Important?
Accrued revenue is an extremely important accounting term, especially to businesses operating under the accrual method. So, why is accrued revenue so important?
Financial Reporting System
Accrued revenue is important for an organization as it ensures its financial records are accurate. For businesses involved in long-term projects or providing subscription-based services, any income received needs to be booked the moment the work is completed or even when the service has been provided. In the absence of this, financial statements might show an inaccurate picture of profitability and the company’s health.
Efficient Cash Flow Management
One can monitor when the customer will make payment and therefore plan the cash flow appropriately. This way, a business ensures it has sufficient liquidity to cover other expenses irrespective of the timing.
Better Decision Making
The actual financial records result in the system of good decision-making. It ensures that management has a very clear picture of earnings from the business, which aids in deciding on budgeting, investments, and other operational issues.
Accounting Standards Compliance
Increased accrual of revenues increases a company’s adherence to GAAP or IFRS. The two have standards that revenue earnings are to be reported once achieved rather than the time earned. This can result in misleading financial statements and, subsequently, lead to regulatory problems if inaccurately accounted.
Investor Confidence
Accrued revenue and the actual financial statement are needed to assess the performance of the business enterprise. Accrued revenue provides clarity about the enterprises’ cash flows, which can make it easier for investors to have a better opinion on the health and potential growth of a business.
What Did We Learn?
Accrued revenue is not only a concept in accounting but also a crucial financial tool for providing clear and accurate views of the financial position of businesses. It ensures that revenues are recorded as they accrue, thus completing the principles as held in accrual accounting. This concept is highly important in industries with delayed payment cycles, which include subscription services, long-term contracts, and interest-based businesses. Recordable accrual of earned revenue ensures better financial reporting, enhanced management of cash flow, and conformity with accounting standards.
Thus, the correctness of the accrual of earned revenues builds greater trustworthiness and transparency in statements of account. Moreover, it helps an enterprise assess its long-term options for making decisions about resource allocation and strategic planning. Investors, regulators, and management will use accruals of earnings to evaluate the company’s future income-generating potential, liquidity, and overall performance in the area of financial results. A business will report less revenue without accrued revenue, hence creating a very poor planning, and cash flow may at some point become undisciplined.
Thus, a firm should consider the accrued revenue as an excellent avenue that enables the bridging between earning income and receivables collection, so that the firm’s book keeps reflecting the real value of the operations conducted. The ability of this to have its investors remain confident, comply with the regulatory requirement and develop sustainable growth throughout their operations.
Also Read:
The Complete Guide to Marketing Techniques and How to Boost Your Online Presence
