Accrued revenue.
Revenue earned for goods or services delivered but not billed to the customer yet.
This is sometimes called unbilled revenue.
Let me tell you a little secret.
The finance and accounting team does not really like accrued revenue.
But if we have to record accrued revenue as an adjusting entry, in order to state the
books correctly, we will!
In some companies, there is no need to record accrued revenue.
In other companies, due to their operational process, their billing process, or the way
their systems are set up, accrued revenue journal entries are needed at the end of the
accounting period.
Here’s one such example: a service company that repairs and services heating systems
in buildings.
Their process is for the service engineer to fill in a paper timesheet upon completing
the work, which gets signed off by the customer.
This is an important step: it confirms that the performance obligations in the contract
have been met, which is key for revenue recognition.
Once the service engineer gets back to the office the timesheets are handed in to the
finance team who prepare an invoice for the customer,
and post that invoice to the general ledger.
At the end of the accounting period, the following happens.
There are unprocessed timesheets for service work delivered in December.
The invoicing system for the period of December is already closed, however the general ledger
for December is still open.
The finance and accounting team will record an accrued revenue adjusting entry, to still
“catch” the revenue in the books for December, and then invoice the customer in January.
It’s labor-intensive, but you make sure the books are correctly stated.
A second example is systems-driven.
A company’s invoicing system is structured by week, and has 13 weeks in one quarter.
The company’s general ledger is structured by month.
Every month, the invoice data is uploaded through automated journal entries into the
general ledger.
Weeks 1 through 4 into January.
Weeks 5 through 8 into February.
Weeks 9 through 12 into March.
As the company is working with really tight deadlines for its quarter closing, having
to report final results right at the end of week 13, there is no time to load the actual
invoice data of week 13 into the general ledger.
Just like in the previous example, there is a workaround, which is called accrued revenue.
Let’s review what’s needed in this situation.
The invoices from weeks 1-12 are correctly posted in Q1.
The invoices from week 13 get posted by the system to Q2.
The finance and accounting team will have to record an accrued revenue adjusting entry
in March (on an aggregated level by product line) to state the books for Q1 correctly.
Then in Q2, the week 13 invoice detail gets posted by the system, and the manual accrued
revenue journal entry made in March needs to be reversed in April.
The finance and accounting team does not really like
the manual process of recording accrued revenue.
But if we have to record accrued revenue as an adjusting entry, in order to state the
books correctly, we will!
It’s a matter of principle, more specifically the matching principle.
Expenses should be recorded during the period in which they are incurred.
Revenues should be recorded during the period in which they are earned.
Here are the journal entries for accrued revenue.
Step one is the adjusting entry at period-end.
Debit accrued revenue on the balance sheet, credit revenue in the income statement.
Make sure that when you make a revenue accrual, you also post the related journal entry of cost of sales!
Debit cost of goods sold in the income statement, credit inventory on the balance sheet.
This way, the margin that is made on the sales is stated correctly!
Step two is to issue the invoice in the new accounting period.
Debit accounts receivable on the balance sheet, credit accrued revenue on the balance sheet.
This brings the balance of the accrued revenue account on the balance sheet back to zero,
it is cleared out.
If you record to accounts receivable on the balance sheet, you need an invoice number
and other critical information.
Accrued revenue is an account used on a more summarized and less detailed level.
Step three is for the customer to pay the invoice.
Debit cash, credit accounts receivable.
At the end of the billing and collections cycle, we have 100 of revenue in the income
statement, 100 of cash in the bank, and 50 in cost of goods sold, but it took us an extra
journal entry, through the accrued revenue account on the balance sheet, to get there.
In an ideal world, the finance and accounting team minimizes the number of manual journal
entries, and tries to automate recording invoices and related general ledger bookings as much
as possible.
There is an opportunity in both of our earlier examples to do just that.
Can we change from a three step accrue-bill-collect process to a two step bill-and-collect process?
That might give us the opportunity to generate cash quicker!
In the service and repair company, we could invest in automation.
If we streamline the timesheet and invoicing process,
we won’t need accrued revenue journal entries anymore!
We change the service delivery and billing process, by providing the service engineers
with a tablet that has a timesheet application installed.
Right after the customer puts her signature in the signature field of the electronic timesheet,
the service engineer presses send, the timesheet is transferred to the billing system, and
an automated invoice is generated and e-mailed to the customer.
This way, for all the service work delivered in the month of December, invoicing matches
work performed 100%, and no accrued revenue adjusting entries needed.
A more robust and far less labor intensive process.
For the second example, changing the reporting deadlines
for final results can make all the difference.
If the batch of week 13 invoices can be posted regularly into the general ledger, and the
quarter close activities are carried out AFTER that, then no accrued revenue adjusting entries
are needed, and the invoice subledger detail exactly matches the general ledger information.
Adjusting journal entries… it’s a matter of principle: the matching principle.
Expenses might need to be accrued, or transferred to the prepaid expenses account.
Revenue may need to be accrued or deferred!