Revenues are one of the top indicators of a company’s performance. The higher the revenues of a company are, the higher its profits will be as well. However, higher-income doesn’t always mean higher cash flows. Its mainly due to some companies making sales on credit terms, which means they will receive the cash against it in the future.
What is Accrued Revenue?
Accrued revenue is any revenue earned by a company or business for which it hasn’t received a payment at the time of delivering the goods. Accounting standards require a company to recognize revenues when it earns them, not when it receives cash. Therefore, companies that make sales on credit terms will always have to record or recognize accrued revenues.
There are various reasons why companies record accrued revenues. Firstly, because of the accruals concept of accounting, companies record revenues when earned, not when a customer pays for them. Secondly, it also follows the matching principle of accounting, which states that companies should record an expense in the same period as revenues it helped generate.
Practically, accrued revenues can come up due to various types of transactions. For example, it can happen when a company delivers goods but does not bill the customer at the time. Similarly, it can happen for long-term projects, where companies recognize revenues based on the percentage of completion method. Companies can also record accrued revenues on the interest income from loans given to others.
Preconditions for recognizing Accrued Revenue
Companies cannot record accrued revenue in every single case. Therefore, there are some preconditions attached to recognizing revenues to satisfy the requirements of the accounting standards. Some of the preconditions necessary for recording accrued revenues are as follows.
First, a company must have already earned revenues for it to be able to record them. It means that there should be a delivery of products or services to the company’s customers. If a company has delivered only a part of its products or services from a large contract, it must estimate the portion of the delivered goods and recognize the revenue for that portion only.
Similarly, the company must estimate or calculate the value of the goods or services delivered. In case it cannot measure their value, it cannot recognize revenues related to them. Furthermore, the company must evaluate whether the customer can, with reasonable certainty, pay for the delivered goods.
Lastly, it is also vital for the company to have persuasive evidence of an arrangement for recognizing accrued revenues. This evidence may be in the form of a written or oral agreement with the customer that is binding.
In its most basic form, accrued revenues come in accounts receivable balances from customers to whom a company makes credit sales. When a company makes credit sales to a customer, it must record the accrued revenue when it delivers the goods or services to the customer. The journal entry to record accounts receivable balance and the associated accrued revenues for the customer is as follows.
Before recognizing the accrued revenue for a customer, the company must ascertain that it meets the prerequisites or preconditions needed to record it. If a transaction does not satisfy the aforementioned preconditions, the company cannot record the sale transaction.
Once the customer repays for the goods in the future, the company must remove the related accounts receivable balance. However, the double entry for the eventual repayment will not affect the related accrued revenue recognized in the accounts. Similarly, if the customer fails to repay the company, the accrued revenue recognized will remain unchanged.
A company, ABC Co., makes sales of $10,000 to a customer. The customer does not make any payment against the revenue but promises to repay the company in 30 days. ABC Co. delivers the goods to the customer. ABC Co. believes the sale transaction meets all the preconditions necessary for it to recognize an accrued revenue.
Therefore, the company must record the revenues from the customer as accrued revenues. The double entry that ABC Co. will use to record the transaction is as follows.
Eventually, when the customer repays the balance, ABC Co. can credit the accounts receivable balance and debit the mode of receipt from the customer.
Accrued revenues are revenues earned by a company but for which the customer hasn’t made a payment. The reason why companies record accrued revenues is to conform to accounting standards and concepts, such as accruals and matching concepts. However, companies must first ensure a transaction meets the preconditions necessary to recognize it.