Unbilled Revenue: Accounting Treatment and Impact on Financial Statements
Understand how unbilled revenue is recognized, its role in accrual accounting, and its influence on the accuracy of financial statements.
Companies often perform work or deliver services before issuing an invoice. This earned but not-yet-billed amount is known as unbilled revenue. Properly accounting for it is necessary for accurately reflecting a company’s financial performance and position. Missteps in handling unbilled revenue can distort earnings reports and provide a misleading picture of operations.
Understanding the accounting treatment for unbilled revenue helps in analyzing financial statements and managing business finances effectively. It ensures revenues are recognized in the correct periods, aligning with accounting standards.
Situations That Generate It
Unbilled revenue typically arises from timing differences between earning income and issuing an invoice. This gap occurs frequently across various business models.
Companies involved in long-term projects, like construction or custom software development, often earn revenue as work progresses but may only bill upon reaching specific milestones or project completion. This creates periods where significant revenue is earned but not invoiced.
Service businesses also commonly encounter unbilled revenue. A consulting firm might perform work throughout a month but send a single invoice at month-end or later. Subscription services, such as Software-as-a-Service, earn revenue continuously, but if billing occurs quarterly, annually, or after the service period, unbilled revenue accumulates.
Usage-based models, seen in utilities or some tech services, generate unbilled revenue because consumption must be measured before invoicing, often after the period ends. Internal administrative delays or contractual terms specifying billing intervals can also lead to lags between earning revenue and invoicing.
How It Affects Financial Statements
Unbilled revenue directly impacts a company’s balance sheet and income statement, aligning financial reports with economic activity under accrual accounting.
On the balance sheet, unbilled revenue is recorded as an asset. This represents the value of work performed for which payment is expected but not yet invoiced. It’s usually classified as a current asset, anticipating conversion to cash within the operating cycle. This asset differs from standard accounts receivable, where an invoice has already been issued. Accounting standards sometimes refer to this as a “contract asset,” especially if the right to payment depends on fulfilling further obligations.1Construction Financial Management Association. Topic 606: Classification & Presentation of Retainage & Contract Assets & Liabilities
Recording unbilled revenue also increases the reported revenue on the income statement for the period in which it was earned. This reflects the company’s performance more accurately than tracking cash receipts alone. Failing to account for unbilled revenue understates revenue and profit for the period.
Recognizing revenue on the income statement requires a corresponding asset on the balance sheet. This affects financial ratios; for instance, higher current assets impact liquidity measures, while increased revenue affects profitability metrics. However, unbilled revenue does not immediately increase cash flow; cash is received only after invoicing and customer payment.
Accrual-Based Recognition Considerations
The accrual basis of accounting mandates recognizing revenue when earned, regardless of billing or cash receipt timing. This principle ensures financial reports reflect a company’s economic activities accurately within a given period. For unbilled revenue, this means recording income from delivered goods or services when the work is done, even without an invoice.
Guidance for revenue recognition under U.S. Generally Accepted Accounting Principles (GAAP) comes primarily from Accounting Standards Codification (ASC) Topic 606.2Financial Accounting Standards Board. Revenue Recognition (Topic 606) Project Summary While international companies often follow International Financial Reporting Standard (IFRS) 15.3IFRS Foundation. Project Summary and Feedback Statement: IFRS 15 Revenue from Contracts with Customers These largely converged standards aim for consistency in reporting revenue. Their core principle is to recognize revenue depicting the transfer of goods or services in an amount reflecting the expected consideration.
Applying this principle involves identifying the customer contract and the distinct performance obligations (promises to transfer goods or services). Companies must then determine the transaction price, allocate it to the obligations, and recognize revenue as each obligation is satisfied. Unbilled revenue often arises when obligations are satisfied over time, but billing occurs later.
Central to these standards is the concept of “transfer of control” to the customer. Revenue is recognized when the customer gains control, meaning they can direct the use of and obtain substantially all remaining benefits from the good or service. Control can transfer at a point in time or over time.
Recognizing revenue over time is common in situations generating unbilled revenue, such as long-term projects or ongoing services. This applies if the customer simultaneously receives and consumes benefits, if the work enhances an asset the customer controls, or if the work doesn’t create an asset with alternative use and the company has a right to payment for work done.
When recognizing revenue over time, companies must measure progress using a method that faithfully depicts the transfer of control, such as output measures (milestones achieved) or input measures (costs incurred, hours worked). Reliable estimation is often required. Applying these principles involves significant judgment, and companies must disclose their policies and judgments.
Preparing Adjusting Entries
To ensure financial statements reflect performance accurately for an accounting period, adjusting entries are made at period-end. Recording unbilled revenue is a common adjustment under accrual accounting.
The adjustment captures income earned but not yet invoiced. The goal is to record this revenue in the period the activity occurred. The standard journal entry involves debiting an asset account (like “Unbilled Revenue” or “Contract Asset”) and crediting a revenue account. The debit increases assets on the balance sheet, while the credit increases revenue on the income statement. This requires estimating the value of work completed during the period without an invoice.
These entries are typically prepared at the end of each accounting period (monthly, quarterly, or annually) during the closing process. They address the timing differences inherent between performance and billing.
When the customer is later invoiced for the previously recognized unbilled amount, another entry is made. This entry transfers the balance from the unbilled asset account to Accounts Receivable. It typically involves debiting Accounts Receivable and crediting the Unbilled Revenue/Contract Asset account. This correctly reflects that a formal invoice has been sent and prevents double-counting revenue.