The accrued revenue concept and similar ideas enable sellers and buyers to implement accrual principles accurately. A central tenet in accrual accounting is that sellers claim revenues when they earn them and buyers claim expenses when they incur them. "Revenues" are "earned" as soon as the seller delivers goods or services. They are earned revenues from that moment forward, moreover, even if the customer has not yet paid or if the seller has not sent the customer a bill.

Accrued revenues frequently occur in industries where sellers often delay billing customers. Building contractors, for instance, sometimes wait until a project finishes before billing the customer. One reason they delay is that they may not know the exact bill until the project completes. Another reason for the billing delay is that some customers may be unwilling to pay "up front" for services before delivery.

 

 

Accrued revenues also appear in industries where service providers make long-term contracts with customers for periodic payment, instead of billing them each period. Those who provider floor space for rent or lease usually contract for payment this way, for instance. Maintenance and cleaning services sometimes do business this way, as well. And, providers sometimes continue service delivery even when the customer payment is weeks or more in arrears. In all such cases, sellers accrue revenues when buyers continue using services when payment is past due.

Explaining Accrued Revenue in Context

Examples below show two typical accrued revenue situations. Firstly, a landlord "accrues" revenues in a prepayment situation, when a tenant misses a rent payment but occupies the rental floor space anyway. The second example illustrates a "delayed payment" situation that creates accrued revenues for a service provider. Both examples show the following:

• The "accrued revenue" concept enables sellers to claim revenues when they earn them.
• Accrual accounts such as "Accrued revenue" are temporary asset accounts. Sellers claiming funds with these accounts ultimately move funds into more permanent asset accounts.
  • When the seller invoices (bills) the customer, the funds move into Accounts Receivable.
  • When the customer pays, the same value moves into Sales Revenues.

Accrual accounting uses several similar-sounding terms to classify the results of accruing and deferring payments. To avoid confusion, the following sections explain "accrued revenue" in context with related concepts, emphasizing four themes:

• First, how accountants define Accrued Revenue, along with interchangeable terms isuch as Unrealized Revenues, Accrued Assets, and Accrued Sale.
• Second, how accrual concepts implement the Matching Concept in Accounting.
• Third, example transactions that Accrue Revenue for sellers.
• Fourth, how Revenue Accrual impacts other accrual concepts, including Unearned Revenue, Unrealized Revenue, and Deferred Charge.

• What is accrued revenue?
  • Define Accrued reveue. 
• Prepayment example: How does an overdue rental payment create accrued revenue for the landlord?
• Accrued revenue when the seller delays billing
• Related accrual concepts in prepayment and late payment situations
  • Prepayment(payment precedes delivery of goods or services).
  • Deferred payment (delivery of goods or services precedes payment) 
  • Accrued revenue vs. Accrued income
• Do Accrued revenues exist with cash-basis accounting?

Related Topics

• See Accrual Accounting for an explanation of accrual accounting principles.
• For more example transactions illustrating accrual concepts, see the articles:

Suppose, for instance, that a tenant renting floor space from Grande Corporation has a monthly rent payment of $2,000 due on 1 January as prepayment for January occupancy. Suppose also that the tenant does not pay by that date or even by the end of January, but still occupies the floor space throughout January. Note by the way that the landlord does not entirely earn the January rent revenues until the end of the month.

However, by 31 January, even though Grande does not yet have the rent cash in hand, Grande can now recognize the revenue as accrued revenue (or "accrued assets," or "unrealized revenue"). At this point, Grande could make the two journal entries appearing in Exhibit 1. Firstly, Grande debits (increases) an asset account such as Rent receivable for $2,000. Secondly, Grande credits (increases) a revenue account such as Rental properties revenue for $2,000.

Grande can recognize the rent due as an accrued revenue in this way because Grande believes the tenant will indeed pay. Grande knows, in other words, it can realize the revenue.

Note especially, that if Grande's fiscal year ends 31 January, the Rental properties receivable claim—accrued revenue claim—enables Grande to claim the January revenue earnings for the year.

Transactions When the Customer Finally Pays

Then, when the customer does pay, the overdue January rent on, say, 10 February, Grande would likely make two more journal entries.

• Firstly, Grande debits (increases) one asset account, such as Cash by $2,000.
• Secondly, Grand credits (decreases) another asset account, Rental properties receivable, by the same $2,000. These transactions appear in Exhibit 2.

With these final two transactions, $2,000 change from the temporary "accrued" status and turn into cash assets.

Service delivery providers also accrue revenues in situations where seller and buyer agree to delay billing. Suppose, for example, the consultancy Marcus & Associates (the seller) and its client, Grande Corporation (the buyer) contract for three months of consulting services as follows:

• The consultant will ultimately bill the client $20,000 for each month of service delivery. In such cases, seller and buyer refer to the end of each delivery month as a milestone.
• The consultant will submit an invoice for payment (bill the client) only after reaching all three milestones.

Marcus & Associates deliver consulting services to Grande Corporation for the full month of June, thus completing the first milestone on 30 June. At that point, Marcus claims accrued revenues as Exhibit 3 shows.

Note that Accrued billing is an asset category account, while Consulting service revenues are, of course, a revenue account. When Marcus reaches the second milestone at the end of July, the firm records two more transactions in the same way (Exhibit 4).

Now, on 31 July, both the June and July Accrued billing transactions together constitute $40,000 in accrued revenues.

Third Milestone and Customer Billing

Marcus & Associates reach the third and final milestone on 31 August. Instead of making more Accrued billing entries, however, the consulting firm can now turn all revenue earnings into Accounts receivable and bill the client.

Marcus takes the first step towards Accounts receivable by reversing the previous accrued revenue transactions, as Exhibit 5 shows.

The Accrued billing account now has a balance of $0 while the Consulting services account also has—for just a brief moment—a $0 balance.

Marcus now transforms the former accrued revenues—along with payment due for the third milestone—into the full Accounts receivable. And, at the same time, Marcus brings the Consulting services revenue balance to its total value. Marcus now bills the customer and makes the entries appearing in Exhibit 6.

When the customer pays, Marcus will of course decrease (credit) Accounts receivable by $60,000 and at the same time increase (debit) Cash by the same amount. Note, however, that the accrued revenue concept enables Marcus to put earnings "on the books" as soon as the firm earns each revenue increment.

The accrual terms above—including accrued revenue—are conventions made necessary by the accrual accounting matching concept. Matching means that firms record revenues in the period they earn them, along with the expenses they incur in for earning them. "Matching" revenues and expenses in this way ensures that firms report the period's profits accurately.

The challenge for accountants, however, results from the dual-event nature of sales transactions, and with the accrual definitions of earning and owing.

• A complete sale has two parts: (1) The seller delivers purchased goods or services, and (2) The buyer pays. These events may occur in either order.
• In accrual accounting, moreover, earning coincides with service or goods delivery, while owing coincides with consumption of goods or services. Cash payment and cash receipt are entirely different events.

Both parts of the sale may coincide, as in retail shopping. Or, either part may precede the other with a time lapse between them. For instance:

• Delivery occurs first when the customer buys using credit issued by the seller.
• Payment occurs first when a buyer prepays for service delivery, as with floor space rental payments due before occupancy begins.

Recording Both Parts of the Sales Transaction

To match earnings and expenses and conform with the matching concept, both the seller and the buyer record the first part of the sale event, as it occurs with two journal entries. Example journal entries of this kind appear above in Exhibits 1, 3, and 4. At this point, both parties have the sale "on the books" even though the sale is incomplete.

Later, when part 2 of the sale occurs, buyer and seller each make another pair of journal entries, such as Exhibit 2, Exhibit 5, and Exhibit 6 show. At this point, the sale is complete.

 Exhibit 4 summarizes the possible accounting results from a sale, after just one part of the two-part sale transaction takes place.

The prepayment situation occurs when customers pay before receiving goods or services. That is the unearned revenue situation, the subject of this article.

• Prepayment for the Seller: Unearned Revenues
  
  The seller recognizes "unearned revenues (or "deferred revenues) as revenues received for goods and services before delivery.
  
  The seller records unearned revenues as liabilities until the delivery of the goods or services. At that point, the funds become revenue earnings for the seller.
• Prepayment for the Buyer: Deferred Expenses
  
  The buyer recognizes "deferred expenses" (or "prepaid expenses" or "deferred charges") when paying for services or goods before delivery. The buyer carries deferred expenses as assets until receiving or consuming the services.
  • A one-year subscription to a computer back up service, paid in advance, is "deferred expense."
  • When firms pay taxes in advance of the due date, they create prepaid expense. 
• For more on the deferred expense concept, see Deferred Expense.
  

A deferred payment situation results when the seller delivers goods or services before the customer pays.

• Deferred payment for the seller: Accrued revenues
  
  In the deferred payment situation, the seller who delivers goods or services before the buyer pays records "accrued revenues" (or "accrued assets," "unrealized revenues," or "accrued sales").
  
  Sellers may post accrued revenues in an asset account, such as Accounts receivable until the customer pays cash. Then, the seller credits (reduces) Accounts receivable, while at the same time debiting (increasing) another asset account, Cash.
  
• From the buyer's viewpoint:
  
  Buyers post accrued expenses, or accrued liabilities in their books, registering their debt for goods and services purchased but not paid for yet.
  • When employers owe their employees salaries or wages for work completed, but not yet paid them, the employer has an "accrued expense." 
  • Interest payable for a bank loan can be an accrued expense. Accrued expenses are first entered into the journal as a liability until paid, at which time the accountant debits (reduces) a liability account while also crediting (decreasing) an asset account, such as "Cash."
• Firms first enter Accrued expenses in the journal as liabilities until they pay them.
  • Firms debit (reduce) a liability account when they pay.
  • At the same time, they credit (decrease) an asset account such as Cash.

Exhibit 5, below, shows the results after the second sales transaction event.

Note, finally, that the term accrued also appears with other kinds of earnings besides sales revenues. One example is "Accrued income." This item is another temporary accrued asset category, referring to income due to one party but not yet paid.

Consider, for example, the investor owner of a bank deposit that earns interest, paid monthly, on the 15th of each month. On December 31, however, the depositor has earned one-half month's "interest" which the investor will not receive until 15 January. Suppose the investor's fiscal year ends 31 December. As a result, the investor claims one-half month's interest earnings for the period ending 31 December, and at the same time carries the unpaid interest income into the next period as Accrued income.

Accrued income, in other words, is merely another instance of a temporary accrual account, handled in the same way as accrued revenue. These accounts (Accrued revenue and Accrued Income) allow employees, investors, and sellers to claim funds owed them at the moment they earn them.

Businesspeople understand that the terms appearing above—including accrued revenue—are concepts in accrual accounting. People sometimes ask if the same ideas are necessary or even apply under the alternative approach, cash-basis accounting. The fast answer to this question is "No."

All of the accrual terms above—including accrued revenue—are conventions made necessary by the basic accrual concept. Firms record revenues when they earn them, and they record expenses when they incur them. In accrual accounting, moreover, earning coincides with service or goods delivery. And, cash-basis firms "owe" only when they consume goods or services. In accrual accounting, by contrast, the payment and receipt of cash resulting from earning or owing are entirely different events.

Cash basis accounting, however, makes no such distinction between events. Cash basis accounting:

• Recognizes expenses only when the customer makes cash payment.
• Recognizes revenues only when the seller receives cash.

Cash basis accounting, in other words, has no use for familiar accrual terms such as accrued, deferred, unearned, prepaid, or unrealized.

Most Business Firms Use Accrual Accounting

Most business firms, worldwide, use accrual accounting and not the more straightforward alternative, cash basis accounting. Medium size firms, large firms, and public companies of all sizes choose the accrual approach just because they cannot meet their recordkeeping and reporting requirements using cash basis accounting alone.

Cash basis accounting is sufficient, however, for some small privately owned firms—those that have few employees, do not buy or sell on credit and own few capital assets. For these firms, the cash-basis approach offers the significant advantage of simplicity over the accrual alternative:

• People with little or no background in finance or accounting readily understand and apply cash basis accounting.
• Small firms using cash basis accounting do not need a trained bookkeeper or accountant.
• The cash-basis approach does not require complex accounting software. Firms can easily maintain a cash-basis system in a written notebook or a simple spreadsheet.

See Cash Basis Accounting for more on the cash-only approach and contrasts with accrual accounting.