Definition of Accrued Revenue
Accrued revenue refers to that part of revenue of the company which is earned but is not billed to the customer since the billing can’t be done until all the conditions for raising the bill have been met by the seller or the service provider, as the case may be. However, owing to revenue recognition principle, the income for the work completed is recognized and this create an asset for the company.
Explanation
Accrued revenue is recorded on the basis of two principles, revenue recognition and matching principle. As per revenue recognition principle, revenue should be recognized when it is earned or when the product or services are provided, irrespective of whether it is received or not. And as per matching principle, revenue should be matched against the expenses incurred to gain such revenue.
The concept is more relevant to service industries where the project continues for more than one accounting period. In such cases, income is recorded as and when performance obligations as set out in the agreement between the parties are completed. The same is as per accounting treatment specified as per GAAP. As soon as all the obligations are completed billing is done and actual trade receivables are booked against accrued revenue.
Examples of Accrued Revenue
Let us take an example of a construction project in which three floors are to be build by the builder in the form of a commercial property. In this case, the performance obligation is to create three floors. Every time a floor is completed it will give rise to the completion of a single performance obligation and the construction company can book the revenue proportionate to a single floor as accrued revenue. When all the floors are constructed then all the performance obligations will be completed and accrued revenue will get transformed to trade receivables.
Let us say the total contract amount for the building is $9,00,000. When the first floor is completed, accrued revenue will be booked by an amount of $3,00,000.
Accrued Revenue in Balance Sheet
Accrued revenue income in shown in the statement of profit and loss, and the accrued revenue receivable is shown in the balance sheet as an asset. They are recorded as receivables and form part of the assets in the balance sheet.
Recording Accrued Revenue
Accrued revenue is recorded as an adjusting entry in the financial statements. Accrued revenue income is credited and shown on the credit side of the income statement and accrued income receivables is debited which is shown on the asset side of the balance sheet. As per the example that we discussed above, the journal entry for accrued revenue shall be as follows:
| Dr. Accrued Revenue Receivables | $3,00,000 |
| Cr. Accrued Revenue Income | $3,00,000 |
The opposite treatment for accrued expenses and liability will be done by the counterparty.
Difference Between Accrued Revenue and Accounts Receivable
Accrued revenue represents that portion of revenue on account of sale of goods or rendering of services for which the billing is not done due to other pending performance obligations in a project. It is booked as an asset in the balance sheet and remains to reflect as accrued revenue receivables until an invoice can be raised. It can’t be considered as a liquid asset since it can normally be converted into cash only when an invoice is raised upon the other party.
On the other hand, accounts receivables represent the amount due from the other party on account of sale of goods or services for which an invoice has been raised. Accrued revenue converts to accounts receivables once all the conditions are fulfilled and an invoice is raised. Accounts receivables are more liquid assets since they can be converted into cash based on the due dates of invoices.
Advantages
Recording of accrued revenue offers following advantages:
- It follows accrual basis of accounting and records the income as and when it is earned. This gives a fair view about the profitability of the company.
- It gives rise to an asset which represents the amounts that a company is expected to realize from the counterparty once the billing is done. This gives transparency to accounts as the management is aware of the amounts that are to realized in the near future.
Disadvantages
Disadvantage linked to accrued revenue recording are as follows:
- Accrued revenue receivables are not liquid in nature as it takes time to convert them into cash. This is why a large amount of accrued revenue adversely impact the working capital.
- The actual amount that is realized later may vary since accrued revenue receivables are booked based on the estimated amount that is to be realized.
Conclusion
The concept of accrued revenue is majorly relevant for the service industry since in case of sale of goods performance obligations are completed along with the transfer of goods and an invoice is raised at the same time.
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