Accrued Revenue: is revenue that is already earned by providing a service or goods, but the cash is yet to be received.
Accrued Revenue Details
Accrued revenue is the revenue that a company or an individual has earned through services offered or goods provided, although the company has yet to receive cash for the goods or services. This accrued revenue is recorded in the receivables account. The Generally Accepted Accounting Principles (GAAP), which also uses the accrual method of accounting, requires that financial transactions be recorded when the transaction occurred. Companies that use GAAP will recognize revenue when it was earned and not necessarily when cash was exchanged.
Usually, in business, expenses are made before revenue is generated. GAAP uses this form of accounting because it seeks to match all revenues to the expenses that were made to secure such revenue. This method makes it easier for companies to match expenses to the revenue generated within an accounting period. An example is when a soap production company sells (ships and delivers) soap to a customer who will eventually pay for the goods in the next accounting period. Although the customer will pay for the goods in the next accounting period, it will be recorded as an accrued revenue in the current accounting period.
Accrued revenue is most prevalent in services industries such as companies that provide subscription-based services. Subscription-based companies usually bill customers at the end of a billing period when they have already consumed the services. Other servicing companies or construction companies use accrual accounting since most of their services are only billed at the end of a project or after reaching specific milestones, which generally take time.
Example of Accrued Revenue
The following example illustrates the concept of accrued revenue and how to record it in financial statements, especially under the GAAP.
Uzwer is an online-based magazine that publishes content that cuts across celebrities in music, art, and comedy. The goal of Uzwer is to provide its readers with detailed information about the lives of their favorite celebrities. Uzwer publishes content every week. Within two years of starting up, Uzwer has become very popular in its home country of South Africa. Three months ago, Uzwer decided to monetize the magazine by charging a weekly subscription fee.
Uzwer decided to provide its customers with the option to subscribe weekly or monthly. Since Uzwer did not include a free trial, Uzwer decided to bill customers at the end of a billing cycle. I am sure this made a difference for customers that decided to stay on with the subscription.
Uzwer’s subscription system offers discounts for customers who choose the weekly billing cycle. A weekly subscription costs $5, which is billed weekly. Customers who choose to pay monthly will be charged $5.5 per week and billed a total of $22 monthly.
Uzwer is using the GAAP, which is based on accrual accounting. This means it must recognize revenue at the time it is earned.
Let’s see how Uzwer earns its accrued revenue. Uzwer earns $5 every week from its weekly subscribers and $5.5 for those who are monthly subscribers. Uzwer earns $5.5 every week for the monthly subscribers but is paid at the end of the month. This means that the $5.5 is accrued revenue until the end of the month when the monthly subscriber pays Uzwer cash.
In the financial books, Uzwer will record these transactions as such:
Annika is one of Uzwer’s customers, and she is a monthly subscriber. A journal entry for Annika at the end of a week will be:
Annika Debit Credit
Accrued Account $5.5
The accrued account in the above journal entry is debited $5.5, while the revenue account is credited $5.5.
Significance of Accrued Revenue
Accrued Revenue is used to balance expenses with revenue that is generated on those expenses. If accrued accounting is not used, it means that accounting books will not truly reflect the true position of a company at a point in time.
For example, imagine a company makes expenses to increase production and sales. The company was able to increase its sales successfully; however, the payments were delayed. Suppose the expenses are recorded, but the accompanying accrued revenue is not recorded. In that case, a look at the financial books will show that the company is in a bad position (with very low revenue). If the payments for the goods sold earlier are now made in the next accounting period, recording such revenue in the new period will exaggerate the company's position (with very high revenue).
GAAP adopted accrued revenue to bring balance between the expenses and revenue in an accounting period.