Accrued revenue is revenue that a business earns for providing goods or rendering services to its customers for which payment hasn’t been made yet. Accrued revenue is an important component of accrual accounting. It is important to understand the fundamental principles of accrual accounting and how these principles are applied in accounting for accrued revenue.
Principles of Accrual Accounting
Accrual accounting operates on two principles namely; the matching principle and the revenue recognition principle. What do the revenue and matching principles imply? The matching principle associates income generated by the business with the expenses incurred in the process of generating the income. The revenue recognition principle on the other hand mandates that every revenue generated must be accounted for within the period it was generated.
For instance, if the accounting year of a business starts on April 1, and ends on March 31, every revenue generated within this period should of necessity be accounted for. No revenue generated within this period should be carried over into the next year.
The Generally Accepted Accounting Principles (GAAP) make provision for the recognition of accrued revenue whenever the parties involved meet up with the agreed obligation. For instance, if a business supplies goods to a client for an agreed price, that business has fulfilled a performance obligation. As a result of fulfilling this obligation, the business becomes entitled to receive revenue from the client. On this ground, the business can record this revenue even if it has not yet been paid by the client.
Accrued revenue is commonly recognized in the financial statement of businesses in the service industry. This could be because the revenue for the service industry is usually paid in milestones or at the end of the project. Most times, these services can last for so many months and the business gets paid completely after the service.
Considering that the revenue generated by these businesses is most time paid in bits, accrued revenue accounts becomes a necessity. With an accrued revenue account, businesses can report revenue generated as they are paid and not wait till the lump sum is fully realized. This will help in the preparation of the accounts and the determination of the true financial position of these businesses.
Let’s say a construction company got a huge project from the government to construct a road network. Based on the terms of service, the government will pay a lump sum of $1 billion. The project in question would last for 10 months. At the end of each month, the company will be paid $100 million from the government. Rather than wait till the 10th month to account for the revenue, the amount paid each month appears on the financial statement.
At what point does Accrued Revenue Occur?
Accrued Revenue occurs anytime there is a time difference between when a transaction took place and when payment was made. Common instances of this occurrence include:
- When projects are long-term and revenue is paid as milestones are achieved.
- When a business gives loans to individuals or other businesses.
Differences between Accrued Revenue and Deferred Revenue
Accrued revenue and deferred revenue are two different accounting concepts. Deferred revenue refers to revenue that is received for which service has not yet been rendered. For instance, if a client pays a business in advance to supply goods but the business has not yet fulfilled the order, the money paid by the client is deferred revenue. On the other hand, businesses recognize accrued revenue before payment is received. The key differences between the two concepts are as follows:
- For accrued revenue, entry occurs for every revenue at the same time. However, deferred revenue is spread across the months.
- In accrued revenue, a cash receipt is expected. Deferred revenue on the other hand recognizes payment long after the cash has been received.
- Accrued Revenue is an asset. This is because the business has already rendered service and is expecting payment. Deferred revenue on the other hand is a liability. This is because it represents unearned income for which the business needs to fulfill an obligation.
Journal Entry for Accrued Revenue
Accrued Revenue appears under current assets on the balance sheet. However, It is treated as an adjusting entry on the financial statement. Its entry on the income statement is however treated as earned revenue since the business has fulfilled performance obligations.
With accrued revenue, when clients eventually make payment, the business records it as an adjusting entry in the journal under the asset account. This entry will only reflect on the balance sheet and does not affect the income statement.
For example, Moringa Company Limited made a deposit of $1 million dollars into its bank account with Polaris Bank on December 15, 2012. The company expects to receive an interest of $800 on the deposit made by February 28, 2013. While preparing the books of account for the company at the end of the year, the journal entry will be as follows:
|Dec. 31||Interest income Receivable||$800|
|Bank Deposit on interest income||$800|
Once the company receives the interest in February, an entry will be made in the journal to balance the account as follows:
|February, 28||Bank Account||$800|
|Interest income Receivable||$800|
Accrued Revenue balances are entered on the balance sheet. The changes witnessed in the revenue as milestones are reached however appear on the income statement.
Is Accrued Revenue an Asset?
Accrued Revenue is a current asset. It is entered under account receivable as it represents the amount of cash a business expects to receive from its client. From a cash perspective, having a high accrued revenue may not be an entirely good thing. This is because there is an indication that the business in question is not getting as much cash payment as it ought to from clients.
Importance of Accrued Revenue
Accrued revenue is a vital part of every business. What are the benefits businesses can derive from recording accrued revenue?
- It helps in the anticipation of possible revenue and expenses.
- Having a record of all expected revenue will help the decision-makers decipher how profitable the business is.
- With accrued revenue accounts, possible problems can be detected on time.
- Accrued Revenue helps in the determination of the true financial state of businesses.
- It helps in determining the impact of sales on general profitability.
Accrued revenue is a vital concept in accounting. Understanding how accrued revenue works can make a whole world of difference in the financial statements of a business.