Accrued and deferred revenues are contrasting accounting entries for a business.
Accrued income is received after providing goods or services. Contrarily, deferred or unearned income is received in advance before providing goods or services.
Let us discuss key differences between accrued revenue and deferred revenue.
What is Accrued Revenue?
Accrued revenue refers to the revenue earned by a business but not received yet. It is earned income against the sale of goods or services rendered.
Accrued revenue occurs when a business offers goods or services in one accounting period and receives payment in another period.
Since accrued revenue is earned and can be reasonably estimated by a business, it is considered a certain income. Therefore, businesses often list it under current assets as accounts receivable.
A business must carefully record accrued revenue as it must fulfill certain terms to avoid manipulation of accounting rules.
Accrued revenue is first listed on the balance sheet of a business as an asset and gradually shifted to the income statement as it receives payment.
What is Deferred Revenue?
Deferred revenue occurs when a business receives payment in advance with an obligation to provide goods or services later.
Deferred revenue is also termed unearned revenue or unearned income for the reason that the business is yet to fulfill its obligation of providing services or goods as per trade terms.
Since a business receives payment in advance, unearned revenue is certain and becomes a legal obligation to provide goods/services. Therefore, a business will record deferred revenue as a short-term liability in its balance sheet.
As the business provides services or goods to its customers, it will gradually shift unearned income as a liability from the balance sheet to the income statement as earned revenue.
How Does Accrued Revenue Work for Businesses?
Accrued revenue follows the accounting principles of accrual accounting. Therefore, a business must record income or expenses when they occur rather than when cash is received.
A business must evaluate the following points to record accrued income:
- It must have a binging arrangement with the customer such as a contract or agreement.
- Contract prices for goods sold or services rendered must be known or can be estimated reasonably.
- The business must oblige its responsibility of providing goods or services to its customers.
- The business can be certain of collecting the receivable revenue.
Once a business evaluates these conditions, it can record deferred revenue in its balance sheet.
For long-term projects and substantially large revenue amounts, a business must proportion accrued revenue. It should only record a proportion of income against which it has provided services or delivered goods.
A business can also enter adjusting entries if the revenue rate is not fixed. Therefore, the total accrued revenue must match the total of goods delivered or services offered at project completion.
Once the business completes its obligation of delivering goods/services, it must shift accrued revenue from its balance sheet completely to the income statement.
How Does Deferred Revenue Work for Businesses?
Deferred or unearned revenue also follows accrual accounting principles.
As a business receives payment in advance, it should record it in its financial statements. However, since the business is yet to fulfill its obligation of providing services or delivering goods, the income is unearned.
Deferred or unearned income is often received in the form of advance payment. A business then completes its trade obligation gradually.
For long-term projects, a business should only record a proportion of the total revenue in the relevant accounting period. In other words, it should spread the total revenue across the length of the project.
As a business fulfills its obligation, it should reduce the current liability of unearned income and record it on the income statement as earned income.
By the end of the project, a business must fulfill its total work requirements and the liability should be reduced to zero.
Accrued revenue and deferred revenue are both common concepts for modern businesses.
Examples of accrued revenue include:
- Interest income when a business offers loans to individuals or businesses
- Income from long-term construction projects where businesses receive income gradually
- Long-term manufacturing or production projects where businesses deliver goods gradually
- Other types of projects where payment is made on milestone terms
Examples of deferred revenue include:
- Advance payments such as rentals, insurance, mortgage, etc.
- Professional service providers such as law firms and consultancies
- Software companies receiving advance payments
- Subscription-based businesses receiving payments in advance and offering gradual services
Accrued Revenue Impact for Businesses
Accrued income is an important concept for businesses working on long-term projects.
Businesses can accurately record revenue where they offer long-term services. Accrual accounting helps these businesses to record income and expense with matching entries and reflect an accurate financial position.
Accrual accounting practice is also subject to bias and manipulation. Managers can easily distort revenue figures and show artificial growth. Therefore, a business must follow accrual accounting practices carefully.
Since cash businesses record an income or expense entry when they receive cash, they do not use accrued revenue.
Businesses would require distinctive analysis to follow the exact cash flow for businesses following accrual accounting principles.
Deferred Revenue Impact for Businesses
Deferred revenue is the total opposite of accrued revenue. Here, a business receives payment in advance and it should provide goods/services as an obligation.
It means a business can utilize cash received in advance to make inventory purchases and other working capital requirements.
Again, a business must carefully practice unearned or deferred income practices. It should only record certain profits and amounts that can be reasonably estimated.
Although unearned income offers a cash buffer to a business, there is always an element of uncertainty. Customers can cancel their orders or can be unhappy with the final outcome of the project which may result in the loss of total income.
Accounting for Accrued Revenue
Accrued income is recorded as a short-term asset under accounts receivable in the balance sheet of a business.
When a business earns accrued income but the payment has not yet been received, it will record the following journal entry:
|Accrued Revenue||$ XXXX|
|Income Account||$ XXXX|
When the business receives cash, the reversal journal entry will be:
|Cash/Bank Account||$ XXXX|
|Accrued Revenue||$ XXXX|
Similarly, a business can record all payments against accrued income.
Accounting for Deferred Revenue
Deferred income is recorded as a short-term liability for a business. As the business fulfills its obligation, it removes the liability and records earned revenue.
When a business receives cash in advance, it will record the following journal entry:
|Cash/Bank Account||$ XXXX|
|Deferred Revenue||$ XXXX|
As the business reaches a contract milestone, it will reduce the liability of deferred income with the following journal entry:
|Deferred Revenue||$ XXXX|
|Revenue Account||$ XXXX|
At the end of the project, the liability should reflect zero balance and the revenue account should reflect the full income.
Accrued Revenue Vs Deferred Revenue – Key Differences
Accrued and deferred revenues act contrastingly. Therefore, their implications and accounting recognitions are also contrasting.
Definition and Concept
Accrued income is earned income where a business has provided goods or services but the payment hasn’t been received.
Contrarily, deferred income is unearned revenue where a business has received payment but the goods or services have not been delivered yet.
Accruals oblige a customer to pay the service provider. Conversely, deferrals oblige a service provider to provide goods or services as agreed.
Accrued revenue is recorded as a short-term asset in the balance sheet. It is the total accounts receivable for a business.
Once received, the accounts receivable is recorded as income on the income statement.
Deferred income is recorded as a short-term liability in the balance sheet of a business. As the business completes its obligation, it records income in the income statement.
Accrued revenue is an asset. A debit entry increases it whenever goods or services are delivered and the payment is accrued.
On the other hand, deferred revenue is a liability. It offers advance cash to a business that helps keep the cash flow smooth.
A credit entry will increase deferred revenue and a debit entry will decrease it.
Both types of revenue offer contrasting benefits in terms of cash and management.
Impact on Business
Accrued revenue is an asset. However, it deprives of cash as the customer delays the payment after receiving goods/services.
Contrarily, deferred or unearned revenue offers advance cash and helps in cash flow management. Though it increases the short-term liabilities of a business.
Pros and Cons for the Business
Accrued revenue and deferred income both help a business follow accrual accounting principles. A business can implement the matching entries principle to accurately represents its balance sheet and income statement.
Accrued income increases the assets of a business but does not offer advance cash. Contrarily, deferred income increases the liability of a business but provides advance cash to a business.