Accrued Revenue: A Practical Guide

If you work for an SMB or a mid-market SaaS company, you know the importance of accurate financial reporting. It can be stressful if your company’s income statement doesn’t reflect the revenue earned in the same period (even if you haven’t received the cash yet).

Accrued revenue is a concept in accrual accounting in which you record revenue when you earn it, regardless of when you receive the payment. 

This situation often arises when a company performs a service or delivers goods near the end of an accounting period, and the customer has not yet paid the invoice by the period’s end. Accrued revenue is recorded as an asset on the balance sheet and is recognized as revenue on the income statement. Let’s take a closer look.

Principles of Accrued Revenue

The main principles related to accrued revenue are the revenue recognition principle and the matching principle. 

Revenue Recognition Principle

The revenue recognition principle states that revenue should be recognized and recorded when you earn it, even if you haven’t yet received actual payment. You recognize the revenue when your company has substantially completed its obligation to the customer. Through this principle,  your financial statements accurately reflect your company’s performance during a given period.

For example, if your SaaS company provides a monthly subscription service and has delivered the service for June, you would recognize the revenue for June even if the customer hasn’t paid yet. 

Matching Principle

The matching principle states that you should record expenses in the same period as the related revenues. So, you’re recognizing revenue and any expenses incurred to earn that revenue. This verifies that your income statement accurately reflects your company’s profitability for a given period.

Say your company incurs sales commissions or hosting costs related to providing your SaaS service. You would record those expenses in the same period as the revenue they helped generate. 

Other Principles to Consider

The accrual principle is a broader concept that encompasses both the revenue recognition and matching principles. It states that you should record your transactions when they occur instead of when you and your customer exchange cash. This includes recognizing revenue when you have earned it and the incurred expenses.

The conservatism principle states that when uncertainty exists, accountants should choose the option that results in less net income and/or less asset amount. This principle promotes a cautious approach to financial reporting and helps you prevent overstating income or assets.

Recording Accrued Revenue

You record accrued revenue using double-entry bookkeeping, which means that each transaction affects at least two accounts. 

When you earn revenue but haven’t billed for it yet, you debit Accrued Revenue (an asset) and credit Service Revenue (income). When you invoice the customer, you debit Accounts Receivable and credit Accrued Revenue. Finally, when your customer pays, you debit Cash and credit Accounts Receivable. 

This system helps you balance your financial statements and have them accurately reflect your revenue, receivables, and cash flows in the appropriate periods.

To record accrued revenue, you’ll need to make a journal entry at the end of the accounting period. This entry will recognize the revenue that your company has earned but not yet billed or paid. 

Here’s how you would typically record accrued revenue:

Step 1: Understanding the Need for Accrual

Accrual accounting is necessary when there’s a timing difference between when revenue is earned and when it’s billed or paid. If you’re recording your numbers, you can see whether your financial statements accurately reflect your company’s performance during a specific period. This is particularly important if your business deals with contracts, subscriptions, or long-term projects.

Step 2: Identifying Revenue to Be Accrued

Start by reviewing your sales contracts, service agreements, and project milestones to identify any revenue that you’ve earned but haven’t yet billed or been paid. This might include completed work for a client, a portion of a subscription period, or goods delivered to a customer. 

You’ll want to determine the amount of revenue to be accrued based on the terms of the agreement and the work you completed.

Step 3: Making the Journal Entry

Record the accrued revenue in your accounting system using a journal entry. The typical journal entry for accruing revenue involves:

• Debiting the accrued revenue account on the balance sheet under current assets. This entry increases the total assets, reflecting the economic resource that the business owns (the right to receive money).
• Crediting the revenue account on the income statement. This entry recognizes the income earned, which will affect the company’s profit and loss for that period.

Example of a Journal Entry

Let’s say your SaaS company provided $5,000 worth of services in June but hasn’t billed the customer yet. The journal entry would look like this:

Now, suppose you bill the customer on July 1st and receive payment on July 15th. The journal entries would look like this:

Step 4: Reversing the Accrual

When you eventually bill the customer or receive payment, you’ll then reverse the accrued revenue entry. You’ll debit (increase) Accounts Receivable and credit (decrease) Accrued Revenue by the amount you previously recorded.

This moves the revenue from the Accrued Revenue account to the Accounts Receivable account, and it reflects that you’ve now billed the customer. When you receive the payment, debit (increase) Cash and credit (decrease) Accounts Receivable to record the payment. This way, you’re not double-counting revenue, and the accounts reflect the current status of receivables and cash.

Step 5: Documentation and Review

Maintain clear, organized records of all accrued revenue transactions, including the amounts, dates, and relevant contracts or agreements. To do this, regularly review your accrued revenue balances to make sure they’re accurate and up to date.

At the same time, compare your accrued revenue records to your actual billings and payments to identify any discrepancies or outstanding balances.

Step 6: Using AR Automation Tools

To simplify and streamline your accrued revenue process, consider implementing accounts receivable (AR) automation software to help you track contracts, automate invoicing, and monitor payment status.

Plus, it can also generate reports and alerts to help you stay on top of your accrued revenue balances and outstanding invoices. Automation can save time, reduce errors, and provide real-time visibility into your revenue and cash flow.

Accrued Revenue vs. Other Revenues

You record accrued revenue when you’ve earned the revenue but haven’t billed the customer or received payment yet. However, accrued revenue is just one type of revenue that your company might record. Here are some key differences between accrued revenue and other common types of revenue.

Deferred Revenue:

• Accrued revenue is the opposite of deferred revenue.
• You record deferred revenue when you’ve billed the customer or received payment but haven’t yet earned the revenue by delivering the goods or services.
• Accrued revenue is an asset on your balance sheet, while deferred revenue is a liability.

Recognized Revenue:

• Accrued revenue is a specific type of recognized revenue.
• Recognized revenue is any revenue that you’ve earned and recorded in your financial statements, regardless of when you receive the cash.
• Other types of recognized revenue include revenue you have billed for and received payment paid in the same period in which you earned it.

Unearned Revenue:

• Unearned revenue is another term for deferred revenue.
• Unearned revenue is recorded when you’ve received payment but haven’t yet provided the goods or services to earn that revenue.

Cash Basis Revenue:

• In accrual accounting, revenue is recorded when it’s earned, which can happen before or after cash is exchanged.
• In cash basis accounting, you record revenue only when cash is received, regardless of when the goods or services were provided.

Having a handle on these differences can help you properly categorize and record different types of revenue in your financial statements. Accrual accounting, which includes accrued revenue, is generally required for companies that meet certain size thresholds or have inventory. However, it’s also a best practice for many businesses as it provides you with a more accurate picture of financial performance over time.

How Does Accrued Revenue Differ From Accounts Receivable?

While accrued revenue and accounts receivable are closely related, there are some distinctions between the two, particularly in terms of their appearance on financial statements and their impact on cash flow.

Both accrued revenue and accounts receivable appear on the balance sheet as assets. Accrued revenue is typically listed under current assets as a separate line item or as part of “Other Current Assets.” Accounts receivable is also listed under current assets, usually as its own line item.

On the income statement, you include accrued revenue in the top-line revenue figure for the period in which it was earned, even though cash hasn’t been received yet. But, accounts receivable doesn’t directly appear on the income statement. It represents money that you’re owed for revenue that you have already recognized.

Neither accrued revenue nor accounts receivable directly impact cash flow until you have received payment from the customer. As accrued revenue represents revenue that’s been earned but not yet billed or paid, it doesn’t immediately affect cash flow. Accounts receivable represents amounts that have been billed but not yet paid, so it also doesn’t immediately affect cash flow.

Both accrued revenue and accounts receivable are important for cash flow forecasting, as they represent future cash inflows that your company expects to receive. When you eventually receive payment, you increase cash flow and reduce the accounts receivable balance.

Practical Examples

To get a better idea of how accrued revenue works in practice, take a look at these three examples:

1. You’ve delivered services but haven’t billed your client: Imagine your company provides consulting services to clients. You’ve completed a project for a client in March, and the agreed-upon fee is $10,000. But, your billing cycle is based on calendar months, so you won’t send the invoice until April 1st. In this case, you’d record $10,000 of accrued revenue in March, even though you haven’t billed the client yet. This guarantees that your March financial statements accurately reflect the revenue you earned in that month.
2. You’re earning interest: Let’s say your company has a savings account that earns interest. The bank pays interest on the account at the end of each quarter. As of March 31st (the end of Q1), you’ve earned $500 in interest, but the bank hasn’t credited your account yet. In this situation, you would record $500 of accrued interest revenue on March 31st. This way, your Q1 financial statements include the interest income you earned, even though you haven’t received the cash payment yet.
3. You’ve got long-term projects: Suppose your company is working on a long-term construction project. The total contract value is $500,000, and the project is expected to take six months to complete. The client agrees to pay in installments based on the percentage of work completed. As of the end of month three, you’ve completed 50% of the project, but you haven’t billed the client for that work yet. In this case, you would record accrued revenue of $250,000 (50% of the total contract value) at the end of month three. This ensures that your financial statements reflect the revenue you’ve earned based on the work completed, even though you haven’t invoiced the client yet.

In each example, accrued revenue helps to certify that your financial statements accurately reflect your company’s performance in the period when the revenue was earned, regardless of when invoices are sent or payments are received. 

AR Automation and Its Role in Managing Accrued Revenue

AR automation can play a significant role in managing accrued revenue, and it offers a range of features and benefits. 

Key Features

• Automated invoicing and billing: AR automation software can automatically generate and send invoices based on predefined triggers, such as the completion of a project or the end of a billing cycle.
• Payment tracking: AR automation tools can track payments received against outstanding invoices, automatically reconciling them and updating your accounts receivable balances.
• Integrated accounting: Many AR automation solutions integrate seamlessly with your accounting software, automatically updating your financial records as you send invoices and receive payments.

Benefits

• Improved accuracy: By automating the invoicing, payment tracking, and accounting processes, AR automation reduces the risk of manual errors and gives you more reliable financial data.
• Enhanced cash flow: AR automation can help you get paid faster by ensuring that invoices are sent promptly and that payment reminders are sent automatically when invoices become overdue.
• Efficient financial reporting: With AR automation, your financial data is always up to date and accurate, making it easier to generate financial reports and analyze your company’s performance.
• Simplified compliance: AR automation tools make it easier for you to prepare for audits, organize your finances, and adhere to regulations.

Challenges and Best Practices in Accrued Revenue Accounting

While accrued revenue accounting is an important part of accurate financial reporting, it does come with some challenges. 

• • Accurately estimating the amount of revenue to accrue can be difficult, particularly for complex projects or contracts with variable pricing.
  • You may need to rely on estimates of the percentage of work completed or the likelihood of achieving certain milestones, which can introduce some uncertainty into your accrued revenue calculations.

• • While accrued revenue helps you recognize revenue in the correct period, ensure that you bill for that revenue in a timely manner.
  • If you don’t invoice promptly, you may end up with a large balance of accrued revenue that hasn’t been billed, which can negatively impact your cash flow and make it harder to collect payment.

• • The matching principle in accounting requires that you match expenses to the revenue they help generate.
  • With accrued revenue, you may need to estimate the expenses associated with that revenue, such as the cost of goods sold or the salaries of employees who worked on the project.
  • Getting these estimates wrong can impact your profitability analysis and financial reporting.

• You may need to adjust your accrued revenue balances if a project takes longer than expected or if the scope of work changes.
• In some cases, you may also need to write off accrued revenue if it becomes clear that you won’t be able to bill or collect payment for that work.
• Managing these adjustments and write-offs can be complex and may require some judgment and analysis.

• Accrued revenue can sometimes create confusion for stakeholders who may not be familiar with accrual accounting concepts.
• You may need to explain to investors, lenders, or other stakeholders why your reported revenue doesn’t match your cash receipts for a given period.
• Clear communication and education can help mitigate this challenge.

Despite these challenges, accrued revenue accounting is still a best practice for most businesses, as it provides a more accurate picture of your financial performance and helps you make better-informed decisions. 

Concluding Thoughts

As you can see, accrued revenue is an important concept in accrual accounting that helps you improve the accuracy and completeness of financial reporting. It may come with its challenges, but with the right tools, you can simplify and strengthen your company’s accounting. 

For a B2B billing and revenue management solution that works the way you do, book a demo with Tabs today and see how we can help you.