Accrued revenue is the recognition of income by the business that has not yet been billed, invoiced, or money received. In today’s accounting tutorial, the last in our series on balance day adjustments, we will look at defining what this type of income is, how does it fit into the accounting conceptual frameworks and then work through an example with journal entries.
The thing to note with all of the work below on accruing income is that this is only carried out in accrual accounting systems. So if a business is operating their system on a purely cash basis these adjustments are not made.
Definition of Accrued Revenue
As we covered in the opening paragraph accrued revenue or income is to bring to account, or recognise, revenue that has been earned otherwise we have not recorded because the customer has either not been invoiced or sent payment.
Please don’t confuse accrued income with credit sales, as I saw on one accounting website I was looking at today. It is not income that has been billed but not yet received, this would fall under sales and debtors. A sales journal would record the invoice being issued, this being a credit, while a debit would be created under the debtors account.
Classification of Accrued Revenue
Accrued revenue is brought to account as a current asset. Under the International Financial Reporting Standards (IFRS) Conceptual Framwork they define an asset along the lines we mention in our prepayments tutorial, being:
… a financial arrangement that creates an obligation on a third party to expend economic benefits to our benefit.
A fancy way of talking about a contract between two or more parties. In the case of our accrued income, this entry arise because we have performed work or provided a good for a third party, under a contract, and are now expecting payment.
Creates an Obligation on a Third Party
As we have performed our side of the contract by delivering the good or service, the contract now requires the third party to perform their side of the deal and pay us the monies owed.
To Expend Future Economic Benefits
The other party in the contract needs to be something that is of an economic benefit to us. That something as per the contract, and in most cases this would be to send us money.
As a Result of Past Events
The accounting standards want to ensure we are not trying to recognise contingent asset events. All of the conditions we set out above have to be present at balance date for the asset definition test to be passed. If they are not then the revenue cannot be accrued.
Accrued Revenue Example and Journal Entries
So that is all of the accounting theory and concepts out of the way, its time to move onto the debits and credits with some journal entries. The fun part of accounting.
ABC Ltd has a year-end balance date of 31 March. As part of its financial management it holds a number of liquid investments, mainly term deposits (or certificates of deposit). On March 21 a new deposit was made for $250,000 paying a generous 5 per cent per annum. This is a 30 day deposit, maturing on April 20. Because of the sums involved the interest earnings on these deposits are accrued for as at balance date.
So we have to do a few workings to get the number we are after, which is what is the earnings for the 10 days from March 21 (the day the deposit was entered into) to March 31 (balance date).
($250,000 x 5%) / 365 days x 10 days = $342
We can now recognise the interest earnings for the 10 days as at 31 March:
|31 March||Accrued Interest||$342|||
The debit creates the accrued interest asset account, ie money they are entitled to receive under the contract but have not. While the credit increases the interest revenue account balance for the year.
Balance day adjustments like this are normally revered in accounting systems after date so that doubling up of amounts are avoided later on. It keeps the system much cleaner going forward. So before the interest is recognised on April 20 we would do the following reversal journal entry:
|31 March||Interest Revenue||$342|||
And then on April 20 when the deposit matures and ABC receives the interest earnings the following journal would be entered:
You can see that net effect of the credit to interest revenue of $1,027 less the interest revenue debit (from the reversal journal entry) of $342, we end up with net interest revenue recognised in April of $685.
Of course this ignores what ABC does with the $250,000 on maturity in April, which might be roll it over into a new 30 deposit. And at the end of April ABC might perform the same accrual entry as we have done here for its internal management accounts.
In today’s tutorial we covered what accrued revenue was, why we classify it as a current asset and then worked through a simple example recognising interest earnings before we received them. We hope this has helped your understanding. If you have any questions from this or any of our material please get in touch or drop us a question using our ask a question page.