What is Accrued Revenue?
Accrued revenue is revenue that has been earned by providing a good or service, but for which no cash has been received. Accrued revenues are recorded as receivables on the balance sheet to reflect the amount of money that customers owe the business for the goods or services they purchased.
Accrued revenue is a sale that has been recognized by the seller, but which has not yet been billed to the customer. This concept is used in businesses where revenue recognition would otherwise be unreasonably delayed. Accrued revenue is quite common in the services industries, since billings may be delayed for several months, until the end of a project or on designated milestone billing dates. Accrued revenue is much less common in manufacturing businesses, since invoices are usually issued as soon as products are shipped.
The concept of accrued revenue is needed to properly match revenues with expenses. The absence of accrued revenue would tend to show excessively low initial revenue levels and low profits for a business, which does not properly indicate the true value of the organization. Also, not using accrued revenue tends to result in much lumpier revenue and profit recognition, since revenues would only be recorded at the longer intervals when invoices are issued. Conversely, recording accrued revenue tends to smooth out reported revenue and profit levels on a month-by-month basis.
Accrued revenue occurs when your company earns revenue for a product or service but hasn’t billed the client or received payment by the end of the financial reporting period. The revenues are recorded as receivables on a balance sheet to reflect the amount of money that customers owe the business for the goods or services they purchased.
Accrued revenue is the product of accrual accounting, which mainly consists of two principles:
- Revenue recognition principle: The principle requires organizations to record revenue transactions within the accounting period when they were earned rather than when they were paid.
- Matching principle: The principle connects revenue generated within an accounting period to the expenses incurred to generate the revenue. Simply put, expenses are “matched” with revenue.
When Does Accrued Revenue Occur?
According to the rules of accrual accounting, revenue should be booked on the income statement when earned and not when the related payment has been received. A potential mismatch between the time a payment is made and when the related goods or services are delivered can create a situation where accrued revenue must be booked.
If the pre-conditions discussed are met, it can happen in several cases. For example:
- When a company loans money to other companies or individuals;
- When a company is involved in long-term projects and books revenue using the percentage of completion method;
- When a company is working on a large order and books revenue based on milestones met.
Let us look at the cases a bit more in detail.
Examples of Accrued Revenue
The first example relates to product sales, where accrued revenue is recorded as a debit, and the credit side of the entry is sales revenue.
On August 31st, a small business ships $25,500 in products to a customer. On September 1st, the business invoices the customer $25,500 for these products shipped on August 31st on account, extending credit with 2/10 net 30 credit terms.
On September 3rd, when closing the books for August, the accountant accrues this earned revenue not yet billed at month-end as the current asset, accrued revenue on the balance sheet, and credits August sales revenue on the income statement.
The second example is accrued revenue for interest income on a loan earned in August for which cash has not yet been received from the payor but is due in September.