Revenue is the receipt of money, or the inflow of economic benefits, due to past events of the firm. As a result of the development of conceptual frameworks, how we define revenue has been changing. However, the accounting entries for revenue has remained pretty much the same, even with the change in definition.
In the machinery rental business, a firm would record as income money it receives to rent out of its equipment to customers. Other firms may receive income from selling books, earning commissions or interest earned on money lent out.
Revenue is the result of the capital invested into the firm by its owners, expenses incurred, assets employed, and any debts incurred in the normal course of business.
Revenue is the main source of activity that will increase the overall net worth of a firm. It achieves this by increasing both sides of the accounting equation; a credit to revenue and a debit to the bank or debtors. Let’s have a look at a couple of examples below.
So far, we have looked at how we define revenue for accounting and examples of what typical revenue items look like. Now it is time to work through how revenue works in the accounting equation and the debits and credits involved in recording revenue transactions.
Accounting Entries and the Accounting Equation
By its nature in the accounting equation, revenue is a credit account. This reflects an increase in revenue the account is credited, while a debit, not normally applied to an income account, would reduce the balance.
The accounting equation provides us with an excellent tool to help show how revenue impacts the firm through the double-entry accounting system. Very briefly, the accounting equation helps us understand the six ways in which money flows into and out of business.
There are only three ways economic benefits flow into a firm for the inflows: liabilities, revenue, and capital. And on the left side of the equation, there are only three avenues for economic benefits to flow out: assets being purchased, expenses being incurred and drawings on owners capital.
Revenue – Cash Sales
On November 15, ABC Ltd carries out some earth moving works for customer XYZ and is paid $10,000 in cash at the end of the contract. In the accounting equation, the business would see an inflow of economic benefits on the right side under revenue, and because it received cash, would record the increase in the bank account as an increase in assets:
ABC Ltd would then make the following accounting entry:
Revenue – Credit Sales
Let us say that instead of receiving cash at the end of the day from customer XYZ, our firm ABC Ltd allows them 15 days to pay the account. ABC Ltd would make the following entry in their accounting system for the work performed (don’t worry about the accounting entry for when the cash is received, we will cover that under the debtors tutorial).
In the accounting equation, you will notice the impacts are in effect the same. Cash and debtors are both assets on the left side, and revenue on the right side doesn’t care what asset account we allocate the $10,000 to.
ABC Ltd would then go ahead and record the transaction in its accounts as:
And that brings us to the end of our article, defining revenue, its accounting equation impact and the journal entries. We mentioned that whether cash is received or a debtor is raised when the income is earned looks pretty much the same in the accounting equation. The left side or debit is either recording under bank (for cash received) or debtors (for revenue on credit).
We trust this article helps you along your accounting path and how accounting helps us understand business. We also welcome your comments, questions and feedback. Please drop a comment below, ask a question on our questions page, or use the Contact Us page.