Accrued revenue is a very common term used when discussing the recording of a company's receivables. This article aims to provide insight into how accruals work.
The article also covers all the basics of what accrued revenue is and why it's important in the accounting process. It also provides tips on how to record it in your accounting system, as well as what methods of payment can be used for accrued revenue.
Finally, this guide provides advice on how businesses can make changes to their adjusting entries for accrued revenues that are invoiced or paid out as part of normal business operations.
What is Accrued Revenue?
Accrued revenue, also known as unearned income, is the amount of money a company has received before performing any services for customers.
Since this revenue wasn't earned at the point it was received, it will be considered an expense once it is invoiced or paid out to customers. To understand why this happens, you simply need to look at how business transactions are recorded by accountants.
Recording Business Transactions
When a customer purchases your business, your accounting department records that transaction in your accounting system. When recording transactions like these, accountants follow the accrual method of accounting and use accrual basis transactions.
What Do These Terms Mean?
The accrual method of accounting means that revenue is recognized when it is earned and not when it's received. This way, accountants can match revenues with the expenses that are directly related to earning that money.
The accrual method is a fundamental principle for businesses because it allows them to present a more accurate picture of their financial health and performance.
This can also help you develop a better budget and make decisions based on actual numbers rather than estimates.
The use of accrual basis transactions refers to the fact that transactions are recorded using the matching principle explained in the previous paragraph—meaning current period revenues are matched against current period expenses, rather than being recorded as they occur. This way, accountants can calculate a company's net income for the period.
Example of Recording an Accrual Basis Transaction on a T-account
Assume that you have a plumbing business in Las Vegas and your company receives $10,000 worth of payments from customers before any services are performed.
Your accountant would record that transaction on an accrual basis. By recording current period revenue as an expense when it is earned, this method makes it clear to all parties involved what is included in the company's net income for that period.
Why Is Accrued Revenue Important?
The recording of accrued revenue occurs for several reasons. Recording revenues when they are earned makes it easier for companies to identify how much money will be included in the current period's net income.
This way, businesses can more accurately predict the cash flows they will have each quarter and throughout the year. It also makes it easier for businesses to accurately report their financial prospects and performance on their income statements.
Recording Expenses When They Are Recorded
Accrued revenue is recorded, just like all other expenses, when the services are performed. The only difference is that accrued revenue comes before the services are performed since it's a financial guarantee that your business will be able to perform work for customers.
This means that you should always make sure to invoice your customers for accrued revenue as soon as possible.
It also means that if you need to take out a bank loan or take out a line of credit with your business owner's assets (like a credit card), you need to make sure that these transactions are booked as soon as possible. This will help you accurately predict your cash flow.
Accrued Revenue Invoicing Cycle
Your billing cycle will dictate how you should record accrued revenues when invoicing customers for services. For example, in a month-to-month business, you should invoice customers at the beginning of the month for any accrued revenues from the previous month.
In other words, if your business operates on a monthly billing system and you receive $10,000 worth of payments from customers before providing any services with this Monday (January 1), your accountant would record those payments as accrued revenue on January 1st.
Changing Your Accrued Revenue Invoicing Cycle
The invoicing cycle you follow is up to you, but it's important to at least have a system that accurately records revenue and expenses according to GAAP standards.
This means that invoices should be performed within a certain time frame, such as daily. This will help your accountant ensure that you have accurate net income at the end of the period, and it will also ensure you are accurately reporting your business's financial health and performance to users of your financial statements.
What Methods Can Be Used to Accrued Revenue?
Just like any other expense, accrued revenue can be invoiced or paid out in other ways. For example, if you do not have an accounting system in place yet but you receive payments for work that has already been performed for your customers, these payments can be considered accrued revenue.
Disputing Accrued Revenue
After performing work for your customers, you should invoice them for any accrued revenues earned during a specific billing period.
Any amounts that are in dispute should be reported as disputed revenue and not recognized until they are resolved. This will help your company avoid overstating any of its financial numbers, which could negatively impact your business's financial performance.
Conclusion
In short, accrued revenue adjustments are necessary when your company has earned income but has not yet received the cash from that income.
The goal is to ensure that your financial statements accurately reflect your company's true financial position. This can be a complex process, but fortunately, many tools and resources are available to help you make the right decisions for your business.
