The difference between income and revenues is self-explanatory. The revenues of a company are the net sales proceeds. However, the income represents the net of revenues and expenses. The revenue recording in the accounting books of an entity is necessary to calculate the net income.
The process is simple in cash basis accounting because there are fewer principles and complicated rules. However, accrual basis accounting is a more popular accounting system that most entities adhere to. Therefore, understanding its principles for accurate recording and preparation of financial statements is necessary.
The revenue recognition principle of the accrual accounting system states that the business entity must recognize the revenue amount when it is earned and not when it is received. The principle outlines the criteria that must be met for recording an amount as revenue earned during a financial period.
The first criterion is the economic transaction of value(goods or services) between buyer and seller. Secondly, the exchange of value must be measurable.
Besides revenue recognition, the matching principle of accounting also has some practical implications on the process of revenue recording. All these principles give rise to different types of revenues and revenue accounts in the accounting books of a business entity.
Unearned revenues and earned revenues are two broader categories that will be targeted in this article. We will discuss both revenues and the main differences between the two.
What are the different types of revenues?
Although the revenue can be divided into different types based on operations, cash or non-cash, unearned or earned, etc., but our focus is on earned and unearned revenues. Still, we will explain different types for a more clear understanding.
The operating revenues of a business entity are the sale proceeds from the operations and activities as mentioned in the company’s memorandum of association.
Comprehensively, the company’s earnings by selling the goods or services as promoted and advertised are categorized as operating revenues. For instance, if a garments company is selling the apparel, the proceeds from sales will be the operating revenue.
Most or some of the business entities also venture into different other businesses besides the primary business. Similarly, many companies also invest in different securities, stocks, etc.
The income or revenues generated from the operations that are not directly related to the company’s main business are recorded as non-operating revenues. The remaining treatment of the revenues remains the same.
Accrued revenues are part of the operating revenues or total revenues of the company. However, not all the sales made by a company are cash sales. Some of the sales proceeds get pending as the sales are made on credit.
The revenue of such sales becomes accrued revenue for the company. The product has been sold, or the service has been provided. However, the customer has yet to pay the price of the product or service.
Some customers pay the companies in advance for the product or service, and it commonly happens in services businesses or insurance companies. The company receives the subscription amount of service at the beginning of the financial year.
However, the revenue is earned throughout the period. The unearned revenue is recorded as the liability of the company. The company keeps crediting the amount to sales and debiting the liabilities as the revenues are earned over time.
Revenues or earned revenues are the total sale proceeds of a business entity during a financial period. Business entities adhere to certain operations like production, selling, distribution of the products or services. These operational activities generate money for the entity, which is recorded as the company’s revenues.
Revenues can be defined as,
‘The revenues of any business entity are the net sales proceeds that are realized and recognized in the company’s accounts by selling a product or service to the customers. Revenues of a company are gross sales proceeds for a specific financial period.’
The revenues or earned revenues of the company can be further sub-categorized as cash and accrued revenues. Both types are included in the total revenues. The recognition of cash revenues and credit revenues is made under the revenue recognition principle and matching principle.
The cash revenues represent the proceeds of the sales that are instantly billed and paid to the company as soon as the transaction occurs. The accrued revenues are the revenues that the company has yet to receive for the Services already provided.
These are revenues that have not been billed yet. Once the accrued revenues are billed, they’re either paid in cash or become account receivable for the billing company.
The recognition criteria of the earned revenues are the same as described in the revenue recognition principle. A business entity will record a proceed or receipt as its operating revenue when the following two criteria are met:
- A critical event must have triggered the transaction process. The critical event refers to the exchange of value between the seller and buyer of the product or service.
- The sales proceeds or amount received against the product or service must be measurable. It implies that there should be a certain level of reliability and validity.
When the company has earned revenue, the following journal entries are made in the accounting books of the business entity.
|(Cash received against the sales account)|
|Account Receivable/ Debtor Account||xxx|
|(Account receivable created against the sales account)|
The earned revenues, credit or cash, are recorded as the top line item in the company’s income statement. All the operating and non-operating expenses, taxes, and interest are deducted from revenues to find the business entity’s net income(profit or loss).
The second broader category of the revenues is the unearned revenues. These types of revenues are not common in the retail industry. However, unearned revenues are common practice in services businesses like insurance, clubs, and large manufacturing corporations. The unearned revenue is also known as deferred revenue.
Unearned revenues for any business entity can be defined as,
‘When the company receives the payment in advance for the product or services to be provided in the future. The amount is recorded as the deferred or unearned revenue. The unearned revenue is a liability for the business entity until the services or products are not delivered to the client.’
Recognition of unearned revenues is also made under the revenue recognition principle and the matching principle. Revenue recognition states that the revenue will be recognized when there is an exchange of value between buyer and seller.
However, when the client pays in advance, there is no value exchanged. Therefore, the unearned revenue is not recorded in the income statement.
Similarly, the matching principle states the recording of revenues and expenses in the period when they were incurred or received. Therefore, unearned revenue is related to the future.
Only the part realized in the current financial period will be recorded as the revenue. For instance, if a gym member pays his annual fees on July 31st and follows a normal accounting year, only five months’ fees will be recognized as revenues.
Since the unearned revenue is not recognized as revenue in the current financial period, it will not be recorded in the income statement. The following journal entry is passed in the accounting books of the company:
|Unearned Revenue Account||xxx|
|(unearned revenue increased against the cash account)|
The unearned revenue is recorded in the cash flow of the company as well as the balance sheet. The cash flow statement shows the unearned revenue as operating cash inflow. On the other hand, the unearned revenue is recorded as a current liability in the balance sheet of the business entity.
Difference Between Revenues and Unearned Revenues
We can summarize the difference between the unearned revenues and earned revenues as follow:
|Earned Revenues||Unearned Revenues|
|Earned revenue is the revenue received or accrued for the services provided or products delivered during a financial year.||Unearned revenues represent the cash proceeds from the clients for which the services will be provided in the future.|
|Revenues are the cash for the products sold or services delivered.||Unearned revenues provide a cash flow for the company to execute the operations and deliver services.|
|What does it tell?|
|It shows how much the company has made in sales.||The unearned revenues of the company show a part of the expected earnings of the company in the future.|
|The revenues of the company are the lifeblood of any business entity. It is an indicator of how much the company is selling in the market and decides its growth.||Unearned revenues are not common in all industries. For instance, insurance industries, services businesses, and large manufacturing companies usually have unearned revenues.|
|The revenues are recorded as soon as the sales are made, either credit or sales. It is the most significant item of the income statement.||Unearned revenues are recorded in the company’s balance sheet under the current liabilities of the business entity.|
We have discussed the major differences between the unearned and earned revenues for any business entity. It is important to differentiate between the two for recording and preparation of the income statements.