Accrued revenue defined: what it is and real-world applications

Have you ever found yourself in a situation where a product or service was delivered, but the payment wasn't received? This scenario is quite common for businesses, especially those engaged in long-term contracts or service agreements.

Understanding the complexities of financial reporting is crucial for businesses seeking long-term success. Among these complexities, accrued revenue stands out as an often misunderstood concept. 

In this article, we will explore the fundamentals of accrued revenue, a concept that bridges the gap between the delivery of a service or a product and the actual receipt of payment. We'll see how accurately recording accrued revenue can help businesses gain a more precise understanding of their financial health and make informed decisions regarding pricing, budgeting, and overall financial strategy.

Main takeaways from this article:

• Accrued revenue refers to income earned but not yet received in cash or invoiced to the customer.
• Companies recognize accrued revenue before receiving payment, especially in long-term contracts and service agreements.
• Accrued revenue plays a crucial role in accurate financial reporting by ensuring the matching principle and adherence to the revenue recognition principle.
• Effective management of accrued revenue involves regular contract reviews, clear communication with clients, and automated tools like ChargeOver.

What is accrued revenue?

Accrued revenue is a financial term representing income earned by a company but not yet received in cash or formally invoiced to the customer. This concept is particularly relevant in situations where businesses provide services or deliver goods over a period of time, even though billing or payment may occur later.

Why recognize revenue before receiving payment?

Companies recognize revenue before receiving payment to accurately reflect their financial performance. In long-term contracts or service agreements, waiting for complete payment before recording revenue would distort the company's income picture. 

For example, say a construction project spans a year, and the client makes milestone payments throughout the duration. If the construction company only recognized revenue upon receiving full payment, its financial statements wouldn't accurately portray the work completed and the value generated in each period. By recognizing revenue as it's earned (accrued revenue), the company provides a more accurate picture of its financial health and operational performance. 

Accrued revenue helps paint a more precise picture of the value generated throughout the project's duration.

Accrued revenue vs. deferred revenue

Differentiating between accrued revenue and deferred revenue is important, as both involve income yet to be received. However, they represent income at different stages of the customer journey.

• Accrued revenue: This represents income earned but not yet invoiced or collected. The customer has already received the goods or service and owes the business money.
• Deferred revenue (unearned revenue): This refers to income received in advance for goods or services yet to be provided. The customer has paid the business upfront, and the business owes the customer the promised product or service.

For instance, a software company might offer one-year subscriptions with upfront annual payments. In this case, the company initially records the received payment as deferred revenue. As the subscription year progresses, the deferred revenue gradually converts into recognized revenue as the company delivers the software service over time.

Accrued revenue is the money you've earned but haven't been paid yet, while deferred revenue is the money you've been paid but haven't "earned" yet because you haven't delivered the goods or services.

The importance of accrued revenue in financial reporting

Accrual accounting plays a vital role in ensuring accurate and transparent financial reporting. Here's why it matters:

Matching principle in accounting

This principle requires expenses to be matched with the corresponding revenue in the same accounting period. Accrued revenue helps businesses comply with this principle by matching earned income with the related expenses incurred even before cash is received.

Accurate financial statements

Financial statements, by including accrued revenue, provide a more complete picture of a company's financial health. They reflect the company's actual economic performance, showcasing the value generated from providing goods or services irrespective of cash collection timing.

Revenue recognition standards

Accounting standards bodies, like the Financial Accounting Standards Board (FASB) in the US, establish guidelines for revenue recognition. The current standard in the US is ASC 606, which emphasizes recognizing revenue when the performance obligation is satisfied. 

This often applies to long-term contracts where revenue is earned and recognized over time as the company fulfills its contractual obligations. Accrued revenue helps businesses comply with these standards by ensuring timely recognition of income as it's earned, even if payments are spread out over time.

How to record accrued revenue

Accrued revenue is recorded on a company's balance sheet as an asset, reflecting income earned but not yet received. Here's an outline of the typical process:

Accrued revenue journal entries

The journal entries for accrued revenue depend on the specific circumstances and the company's accounting practices. The general process involves:

1. Identifying the earned revenue: Determine the amount of revenue that has been earned but not yet invoiced or received in cash.
2. Creating the journal entry: Make a journal entry to record the accrued revenue. The typical entry involves:some text
   • Debit: Accrued Revenue (asset account)
   • Credit: Revenue (income statement account)
3. Adjusting entries: As payments are received or revenue is recognized, journal entries may need to be adjusted to update the accrued revenue account.

Adjusting accrued revenue

Adjustments to accrued revenue are typically made at the end of an accounting period to ensure that the financial statements reflect the correct amounts. Here are three common scenarios where adjustments may be necessary: 

1. When payment is received: If the payment is received before the end of the accounting period, a journal entry is made to debit Cash and credit Accounts Receivable.
2. When revenue is recognized: If the revenue is recognized before payment is received, a journal entry is made to debit Accounts Receivable and credit Accrued Revenue.
3. When adjustments are needed: If the estimated revenue or the timing of payments changes, adjustments may be required to the accrued revenue account.

The accrued revenue account

On the balance sheet, the accrued revenue account is classified as a current asset. It reflects the expected future payments that the company will receive. The balance in this account increases as revenue is earned but not yet received and decreases as payments are received or revenue is recognized.

By correctly tracking accrued revenue, companies can maintain financial statements that reflect their true financial position and comply with accounting principles.

Best practices for managing accrued revenue

Managing accrued revenue effectively requires adopting certain best practices. By following these best practices, companies can reduce errors and ensure compliance with accounting standards.

Regular reviews of contracts

Periodically reviewing contracts is crucial for identifying any changes or amendments that may affect the recognition of accrued revenue. This includes assessing contract terms, milestone payments, and any changes in project scope or timelines. 

Regular reviews help ensure that the company is accurately tracking and recognizing revenue under contractual obligations.

Clear communication with clients

Maintaining open and clear communication with clients is essential for managing accrued revenue effectively. This involves establishing clear expectations regarding project timelines, milestones, and payment terms. 

Regular communication helps avoid misunderstandings and makes sure that everyone understands the revenue recognition process.

Use of automated tools

Leveraging automated tools can significantly streamline the management of accrued revenue. Accounting software and project management tools can help track contract details, milestones, and revenue recognition schedules. 

These tools can automate calculations, generate reports, and reduce the risk of manual errors, ultimately improving efficiency and accuracy.

Stay compliant with revenue recognition standards

Adhering to the latest revenue recognition standards, such as ASC 606, is necessary for companies to maintain accurate financial reporting. 

Companies should stay updated on any changes or updates to these standards and ensure that their practices align with the requirements. This may involve seeking professional guidance or conducting internal reviews to assess compliance.

Real-world applications of accrued revenue

Accrued revenue is a common accounting concept that has widespread applications across various industries. Let's explore some real-world examples to better understand how it works in practice.

Software as a Service (SaaS)

SaaS companies often utilize subscription-based models, where customers pay a recurring fee for access to a software service. In these scenarios, accrued revenue becomes particularly relevant. 

Even though a customer might pay annually or quarterly, SaaS companies typically recognize revenue monthly or quarterly, aligning with the service provided. This reflects the value delivered to the customer over time, even if full payment is received upfront.

Construction

In the construction industry, revenue is generally recognized throughout a project, even if payments are tied to project milestones. 

As construction work progresses and milestones are achieved, the company can accrue revenue based on the percentage of work completed. This approach aligns with the principle of recognizing revenue as services are rendered, regardless of when payments are received.

Consulting

Consulting firms often provide services to customers over extended periods, such as quarterly or monthly engagements. 

In these cases, they may accrue revenue for the work completed during each period, even if the final invoice is not issued until the end of the engagement. This allows for a more accurate reflection of the revenue earned throughout the project.

Manufacturing

In manufacturing, revenue is typically recognized when goods are shipped to the customer, regardless of when payment is received. 

Manufacturing companies typically recognize revenue when goods are shipped to customers, regardless of when payment is received. This is known as the "shipping point" method of revenue recognition. Even if the customer hasn't paid yet, the company has fulfilled its obligation by delivering the product and can recognize the revenue. 

Telecommunications

Telecom companies often have subscription-based services, such as monthly phone plans or internet access. They recognize revenue from these subscriptions every month, even if the customer pays for several months in advance. This approach reflects the ongoing service provided by the telecommunications company.

Challenges in managing accrued revenue

While accrued revenue is a fundamental accounting concept, its management can present certain challenges for businesses, such as:

Tracking multiple contracts

Companies with a large number of contracts may find it difficult to track and manage the accrued revenue for each individual agreement. This can be especially challenging when the contracts have different terms, milestones, and payment schedules. 

The challenge is compounded when the contracts are with different customers, in different locations, and involve different currencies.

Adjusting revenue for partial payments

When a company receives partial payments from its customers, it can be difficult to determine how much revenue should be recognized and how much should be recorded as deferred revenue. Accurate accounting requires careful analysis and calculations. 

The Financial Accounting Standards Board has established guidelines for revenue recognition, but these guidelines are complex and require careful interpretation.

Accurate forecasting

Predicting future revenue streams is an essential part of financial planning and decision-making. However, forecasting revenue can be challenging, especially when dealing with long-term contracts or projects with uncertain timelines.

In these cases, accurately forecasting accrued revenue is critical. This can be done using various methods, including historical data, market research, and industry trends.

Streamline billing and revenue tracking processes with ChargeOver

Managing accrued revenue well is integral to accurate financial reporting and business success. Industries ranging from SaaS to telecommunications rely on this practice, so businesses must remain diligent in tracking and adjusting accrued revenue. 

If you are looking for software to streamline your billing and revenue-tracking processes, ChargeOver offers a powerful solution.

Designed to streamline billing and revenue tracking processes, our platform automates key aspects of accrued revenue management with these cutting-edge features:

• Automated billing cycles: Automatically generate invoices at set intervals to ensure no revenue is missed.
• Payment integrations: Simply integrate with various payment gateways for seamless receipt and processing of payments.
• System notifications: Sends automated reminders and confirmations to clients to facilitate timely payments and track outstanding invoices.
• Customizable invoice templates: Create invoice templates based on specific contracts and clients to reduce repetitive administrative work.
• Real-time insights: Use built-in real-time data analytics features, such as MRR, churn rates, and other financial metrics, to get a snapshot of the company's financial state for timely and data-backed decision-making.

With ChargeOver, you can maintain detailed records of all transactions and adjustments, ensuring transparency and compliance. 

Schedule a Demo and experience the difference for yourself.