How to Record Adjustments for Accrued Revenues

An adjusting entry is an accounting procedure performed at the end of an accounting period to update financial records. These entries are made before financial statements are prepared to account for transactions that have occurred but are not yet recorded in the general ledger. One common reason for an adjusting entry is to recognize accrued revenues, which ensures financial reports accurately reflect a company’s activities under the accrual basis of accounting.

The Principle of Accrued Revenue

Accrued revenue is income a business has earned by delivering a good or service but has not yet received a cash payment. This concept is governed by the Revenue Recognition Principle, which dictates that revenue should be recorded in the period it is earned, regardless of when cash is collected. This principle is a core component of Generally Accepted Accounting Principles (GAAP).

The Matching Principle requires that expenses be recorded in the same accounting period as the revenues they helped generate. Recognizing earned revenue in the period the service was performed allows a company to properly match associated costs, providing an accurate picture of profitability. Without this adjustment, revenue and profit would be understated in the current period and overstated when payment is received.

Examples of accrued revenue are common in business. A consulting firm that completes a project in one month but invoices in the next has accrued revenue. Similarly, a bank earns interest on a loan daily but may only receive the cash payment at the end of the month or quarter. The interest earned but not yet received is another form of accrued revenue.

Calculating and Recording the Adjusting Entry

The first step is to identify and calculate the amount of revenue earned but not yet billed or recorded at the end of the accounting period. This involves reviewing documents like client contracts, work logs, timesheets, or loan agreements. The goal is to find all services rendered or goods delivered for which an invoice has not been issued and payment has not been received.

For instance, a technology company provides $5,000 of support in late December but will not invoice the client until January. As of December 31st, the company has earned the $5,000, and it must be recorded in the December financial statements. The calculation must be based on the service agreement to ensure the correct amount is recognized.

Once the amount is calculated, a journal entry is created to record it. The accountant will debit an asset account, such as Accounts Receivable, and credit a revenue account, like Service Revenue. A debit increases an asset account, reflecting that the company is now owed money, while a credit increases a revenue account, reflecting the earned income.

Using the ongoing example, the company would debit Accounts Receivable for $5,000 and credit Service Revenue for $5,000 on December 31st. This entry formally records the earned revenue in the correct period.

Impact on Financial Statements

The credit portion of the adjusting entry increases a revenue account, which flows to the income statement. This results in a higher total revenue and net income for the accounting period than would have been reported without the adjustment.

The debit portion of the entry impacts the balance sheet by increasing the Accounts Receivable account. This raises the company’s total current assets. Accounts Receivable represents a claim to cash from customers and provides a more complete view of the company’s financial position.

In the $5,000 example, the Service Revenue on the December income statement increases by that amount, boosting the month’s profit. On the December 31st balance sheet, Accounts Receivable also increases by $5,000. This ensures both statements accurately reflect the revenue earned in December.

Subsequent Accounting Period Entries

In the next accounting period, when the company receives the cash payment from the client, a journal entry is made. This entry debits the Cash account and credits the Accounts Receivable account, showing the customer’s debt has been paid. This transaction does not impact revenue for the new period, as it was already recognized; the entry simply converts the receivable asset into a cash asset.

Some companies use an optional reversing entry to simplify bookkeeping. At the beginning of the new period, the accountant records an entry that is the exact opposite of the prior adjusting entry. For the example, they would debit Service Revenue for $5,000 and credit Accounts Receivable for $5,000.

This reversal prevents the revenue from being counted a second time when the actual invoice is processed. The standard billing entry (Debit Accounts Receivable, Credit Service Revenue) and the reversing entry cancel each other out in the new period’s revenue account. This ensures the income is not double-counted while allowing the cash receipt to be processed normally.