Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Accrued Revenue

What it is:

Accrued revenue is revenue recorded in the periods in which it is incurred.

How it works (Example):

Let's assume Company XYZ is a widget consultancy that bills $100 an hour. In January, it performed 7,000 hours of consulting, generating $700,000 of revenue. Company XYZ won't invoice the clients until February.

Accordingly, Company XYZ records the $700,000 in accrued revenue on its January balance sheet and $700,000 in revenue on its January income statement. This way, it has a record that associates the revenue with the month of January even though it hasn't billed the customers yet or received payment for the work.

When Company XYZ sends the invoices out, it converts the $700,000 of accrued revenue to $700,000 of accounts receivable. And when the customers eventually pay, it converts the accounts receivables to cash. All the while, the revenue is recorded in January's income statement.

Why it Matters:

As you can see, accruing recognizes economic events in certain periods regardless of when actual cash transactions occur. Accruing revenue allows companies to reflect the fact that sales may have been made even if cash has not changed hands yet (as is often the case with sales made on credit and similar circumstances). This in turn produces financial statements that are comparable over time.

Although it is more complex, harder to implement, and harder to maintain than the cash method of accounting, most analysts agree that accrued revenue provides a more accurate picture of a company's performance. That's because in any given accounting period, revenues are associated with their corresponding expenses, which gives a truer picture of the operations in a given period.

However, one of the big drawbacks of accrued revenue is that it tends to obscure the nature of the company's actual cash position (e.g., a company may show millions in sales but only have $10 in its cash account because its customers haven't paid yet).