What Is Accrued Revenue? Definition and Examples
Understand how businesses account for income earned but not yet received, ensuring accurate financial reporting.
Accrued revenue represents income a business has earned for providing goods or services, even though the cash payment has not yet been received or formally billed to the customer. This concept is fundamental in accrual basis accounting, which aims to match revenues with the period in which they are earned, providing a more accurate view of a company’s financial performance. It signifies a future economic benefit that the company expects to receive, reflecting a claim on a customer’s assets.
Understanding Accrual Accounting and Recognition
Accrual accounting is a method where revenues are recognized when earned and expenses when incurred, regardless of when cash changes hands. This differs from the cash basis of accounting, which recognizes transactions only when cash is received or paid out. The accrual method is mandated for most businesses in the United States to ensure financial statements accurately reflect economic activity.
The revenue recognition principle dictates that revenue should be recorded when it is realized and earned. Revenue is considered earned when the company has completed its performance obligation, such as delivering goods or rendering services. It must also be measurable and reasonably collectible, even if payment has not yet occurred. This principle ensures financial reports accurately reflect a company’s performance during a specific accounting period.
Common Scenarios for Accrued Revenue
Accrued revenue arises in various business situations where the delivery of a product or service precedes the customer’s payment. For instance, a consulting firm might complete a project for a client at the end of a month but not issue an invoice until the beginning of the next month. The revenue is considered earned in the month the services were performed, creating accrued revenue for that period.
Another common example involves interest earned on investments or loans. If a business holds a bond that pays interest quarterly, but the accounting period ends before the interest is actually received, the earned portion of the interest is recognized as accrued revenue. Similarly, a property owner earning rent from tenants may accrue revenue for the portion of the month that has passed, even if the rent payment is not due until later. Commissions earned by sales personnel on completed sales that have not yet been paid out also fall under accrued revenue.
How Accrued Revenue is Recorded
Recording accrued revenue involves making an adjusting journal entry at the end of an accounting period. This entry ensures that the financial statements accurately reflect all revenue earned during that period. The journal entry involves debiting an asset account, such as “Accounts Receivable,” “Interest Receivable,” or “Accrued Revenue.”
Simultaneously, a revenue account, such as “Service Revenue” or “Interest Revenue,” is credited. This credit increases the reported revenue on the income statement for the period. When the cash is eventually received, a subsequent entry debits the “Cash” account and credits the “Accounts Receivable” or “Accrued Revenue” account.
Accrued Revenue’s Effect on Financial Statements
The recognition of accrued revenue directly impacts a company’s primary financial statements. On the income statement, recognizing accrued revenue increases the reported revenue for the period in which it was earned. This contributes to a higher net income, reflecting the company’s true earnings from its operations.
On the balance sheet, accrued revenue is recorded as a current asset, most often under “Accounts Receivable” or a similar receivable account. This asset represents the amount owed to the company for services rendered or goods delivered. The increase in assets, coupled with the corresponding increase in net income, ensures that the balance sheet remains balanced. This accurate reporting aligns with the matching principle.