Lesson Objectives:- Defining accrued revenue
- How accrued revenue is recorded on adjusting entries
- Revenue recognition principles
- Reporting on the income statement
We've reviewed examples of prepaid expenses, accrued expenses and unearned revenue in the last three lessons. Now let's take a look at the final type of accrued adjusting entry, accrued revenue.
Think of the term of accrued revenue as revenue that has not yet been collected. Essentially the company has earned the money but the cash has not been received in the current month. This type of adjusting entry normally comes into play when a company is providing goods or services but not obtaining payment in advance.
The word accrued is used to describe this type of adjusting entry, as the economic event of providing the service is recognized first, before the cash event.
Let's say we are a consulting company and we have provided $2,000 worth of services that have not yet been recorded. We have incurred all of the expenses related to providing the service, but the funds have not been received yet.
In this example, we would make an adjusting entry to recognize the income that has been earned. The company provides a management consulting service for the full month of May and they bill their clients for $2,000 on the 31st of May. They have earned the money during that month, but they will not receive the payment until the following month. The adjusting entries will need to reflect the revenue that has been earned during the month of May.
In the adjusting entry example above, the debit entry in accounts receivable represents the asset that is owed by the client for the consulting services and earned by the company. The credit entry is for the revenue that the company earned as a result of providing the consulting service.
When we look at the income statement, it reflects the company's expenses and revenues for a specific period of time. Under the accrual basis of accounting, revenues should be recorded when they are earned in order to align the expenses that were consumed.
If revenue is earned during a given month, it should be recorded during that month even if payment has not yet been received. Accrued revenue adjusting entries are needed to account for the funds that have been earned. This concept often applies when a company invoices their clients on credit terms of net 30, 45 or 60 days as the revenue has been earned but the client has a certain amount of time to pay in full.
Above is an example of an income statement for Sam's Appliance Shop. They are currently showing Sales revenue of $ 1,870,841. If the company sold or repaired appliances, and the funds had not yet been received, they would need adjusting entries to calculate the final total of sales revenue that should be recorded.
Adjusting entries are required for accrued revenue as the financial reporting must comply with the GAAP revenue recognition principles. This means that the company must report the revenue that has been earned but not yet collected. Performing the adjusting entries not only allows the company to remain in compliance, but ensures consistent measurement of their financial performance.
Another aspect of revenue recognition is the requirement that the revenue is realized or is expected to be realizable. This simply means that cash is received or is due to be received in the future. In the case of accrued revenue, the revenue needs to be recognized with the adjusting entry before the cash is in hand.
In the next lesson, you will see another example of accrued revenue when we review the concepts of amortization and depreciation.