Unraveling Accrued Revenue: A Beginner’s Guide to Understanding the Journal Entry

As accounting students, you are bound to encounter various accounting terms and concepts that help you capture and report a company’s financial activities. One of the key concepts that play a significant role in maintaining accurate financial records is accrued revenue. Accrued revenue refers to revenue that has been earned but not yet invoiced or received. It’s a crucial concept in accrual accounting, which aims to match revenues and expenses to the period in which they occur, rather than when cash is exchanged.

In this tutorial, we will delve into the concept of accrued revenue, discuss how it impacts the financial statements, and most importantly, walk you through the journal entries you need to make to accurately reflect this revenue in your books.

What is Accrued Revenue?

Before diving into the journal entry for accrued revenue, let’s first define what accrued revenue is.

In simple terms, accrued revenue is revenue that a company has earned but has not yet billed or collected. This typically occurs when goods or services have been provided, but the company has not yet sent an invoice or received payment from the customer. According to the matching principle in accrual accounting, revenue should be recorded when it is earned, not when cash is received. Therefore, even though the payment has not been made yet, the company must recognize the revenue as soon as it is earned.

Here are a few examples of when accrued revenue might arise:

• A company provides consulting services to a client over a period of time but has not yet invoiced the client at the end of the accounting period.
• A law firm provides legal services to a client but has not sent an invoice by the end of the month.
• A company provides a product or service on credit, but the customer has not paid by the end of the accounting period.

Why is Accrued Revenue Important?

Accrued revenue is important because it helps businesses comply with the accrual basis of accounting. Without recognizing accrued revenue, a company’s financial statements could present an inaccurate view of its financial health. If the company delays recognizing revenue until cash is received, it would understate its revenue in the current period and could mislead investors, stakeholders, and management about the company’s performance.

Accrued revenue ensures that businesses:

• Recognize revenue when earned, following the accrual accounting principle.
• Maintain accurate financial statements, providing a true and fair view of the company’s financial performance.
• Comply with accounting standards such as the Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).

Journal Entry for Accrued Revenue

When dealing with accrued revenue, there are specific journal entries that need to be recorded. Here is a simple breakdown of how to record accrued revenue:

1. Record the earned revenue: When revenue is earned, even though cash has not been received, you need to record the revenue in your books. This is done by debiting a receivable account (usually Accounts Receivable) and crediting a revenue account.
2. When payment is received: Later, when the customer makes the payment, you need to reverse the receivable account and recognize the cash received.

Let’s now look at an example and walk through the journal entries.

Example 1: Consulting Service Revenue

Suppose a company, ABC Consulting, provides consulting services to a client, XYZ Corporation. The company completed $5,000 worth of consulting services for XYZ, but has not yet invoiced the client at the end of the accounting period.

Journal Entry for Accrued Revenue at the End of the Period:

Since the revenue has been earned but not yet invoiced, ABC Consulting needs to record accrued revenue.

• Accounts Receivable is debited because ABC Consulting is expecting to receive payment in the future.
• Consulting Revenue is credited to reflect the revenue earned from the consulting services provided.

Journal Entry When Payment is Received:

Later, when XYZ Corporation pays the amount due, ABC Consulting will need to adjust the books to reflect the cash receipt.

• Cash is debited because ABC Consulting has received the cash.
• Accounts Receivable is credited to eliminate the outstanding amount that was previously recorded.

Impact on Financial Statements

Now that we have made the journal entries, let’s examine how these affect the financial statements.

Income Statement

On the Income Statement, the revenue of $5,000 will be reported under “Consulting Revenue” for the period in which the services were provided, i.e., December. This is because the revenue was earned in December, even though payment wasn’t received until January.

Balance Sheet

On the Balance Sheet, the Accounts Receivable of $5,000 will appear under current assets at the end of December. Once the payment is received in January, the Accounts Receivable balance will be reduced, and Cash will be increased accordingly.

Example 2: Law Firm Services

Imagine a law firm, XYZ Legal, provided legal representation to a client for $2,000. The services were completed by the end of the month, but the law firm has not yet sent the invoice.

Journal Entry for Accrued Revenue at the End of the Month:

• Accounts Receivable is debited to show the amount owed by the client.
• Legal Service Revenue is credited to recognize the revenue earned.

Journal Entry When Payment is Received:

• Cash is debited when the payment is received.
• Accounts Receivable is credited to eliminate the balance once the cash is collected.

Example 3: Product Sales on Credit

Let’s say a company, DEF Enterprises, sells $3,000 worth of goods on credit to a customer. The goods were delivered, but payment has not been received by the end of the period.

Journal Entry for Accrued Revenue:

• Accounts Receivable is debited to record the outstanding balance.
• Sales Revenue is credited to recognize the revenue earned from the sale of goods.

Journal Entry When Payment is Received:

• Cash is debited to reflect the receipt of payment.
• Accounts Receivable is credited to reduce the outstanding amount.

Practice Questions

Now that we’ve gone through the concept of accrued revenue and journal entries, let’s test your understanding with a few practice questions.

Question 1:

A company provides services worth $10,000 to a client but has not yet billed them by the end of the period. What is the journal entry to record the accrued revenue?

Answer:

Question 2:

A consulting company, XYZ Consulting, completed a $4,000 project for a client but hasn’t sent the invoice yet. What is the journal entry at the end of the month?

Answer:

Question 3:

A company, ABC Enterprises, provides $2,500 worth of goods on credit, but the customer has not yet paid by the end of the period. What is the journal entry for the accrued revenue?

Answer:

Conclusion

Understanding accrued revenue and the associated journal entries is essential for proper financial reporting and compliance with accrual accounting principles. By recognizing revenue when earned, even if cash has not been received, businesses can provide a more accurate representation of their financial performance. Through examples and practice, you can now confidently make the necessary journal entries to ensure your financial statements reflect earned revenues, whether or not payment has been received. Keep practicing, and you’ll have this concept mastered in no time!