The iconic cover of The Hobbit by J.R.R. Tolkien shows a dragon (Smaug) gloating on top of his pile of gold. While we all wish to be like Smaug, counting the cash we have today, SaaS companies need to think ahead. Revenue accruals are how we do that. But instead of counting what we have today, SaaS companies use a ledger to add up all the gold—I mean, cash—that they one day will get.
Here’s what you need to know to stop thinking like a dragon and start thinking like a SaaS leader.
Revenue Accrual Definition
Revenue accrual is what occurs when a sale is recognized by the seller, but not yet billed to the customer. It’s a financial practice used in businesses with revenue timelines that would otherwise be delayed.
Revenue accrual is commonplace in the service industry, because these projects can take months—or years—to complete. Therefore service companies delay the final transaction, allowing the customer to settle their account once the project is over. Revenue accrual is a crucial practice in situations like these. If a record of expected future profits was left off of a company’s financial statements, it would throw off all revenue accounting, causing massive spikes when invoices are issued before dipping terrifyingly low while the company waits for the next influx of cash. This is not only a concerning trend line to track, it’s a complete misrepresentation of the organization’s value.
Revenue accrual is a practice that came about to help companies abide by GAAP (generally accepted accounting principles) standards and compliance. Two in particular: revenue recognition and revenue matching. Revenue recognition requires revenue transitions to be recorded in the same accounting period, and matching is an accounting concept that seeks to tie revenue generated in an accounting period to the expenses incurred to generate that revenue.
What is the Entry for Accrued Revenue? How to Record Revenue Accrual
In order to properly document revenue accrual, you must create an adjusting journal entry during the accounting period at hand. Makes sense, right? A journal entry that shall be adjusted for revenue that will be acquired later.
When entering accrued revenue in a journal, the debit balance in an accrued billings account appears on a balance sheet and the monthly change in the consulting revenue account goes on the income sheet.
Companies that do not have a gap between their sales and the billing of an invoice and colleciton of payment use a method of revenue recognition called cash basis accounting. This method of recording accounting transactions for revenue and expenses happens only when cash is received or payments are made. And it works in compliance with the GAAP since industries that use this have little to no gap in between the initial sale and the final payment.
How Do You Calculate Revenue Accrual?
A quick little step-by-step for calculating and documenting accrual revenue:
- Recognize the accrual revenue amount on an income statement through credit to revenue.
- Debit the associated accrued revenue account on the company balance sheet by that same amount.
- Record the adjustment to the asset account for accrual revenue when the customer pays (thsi only affects the balance sheet).
- Make the journal entry as the amount of cash received by the customer is debted to the cash account on the balance sheet and the same amount is credited to the accrued revenue account for the accounts receivable account.
But truthfully, revenue accrual is calculated differently based on the company and the timeline of payments, so it is easier to understand the calculation and documentation of such in an example. So keep chuggin on to the next section to understand exactly how accrued revenue works in a real-world context.
What are Three Examples of Accrued Revenue?
Alrighty, let’s hop to it. Here are some real world-style examples to get you started with utilizing revenue accrual for best accounting practices.
Michael Jackson made an agreement with Hess Trucks; every month, they send him a new toy. This agreement lasts an entire year, with Jackson receiving 12 trucks total.
Hess Trucks cites each truck shipped to MJ as a project milestone, and thus, they recognize the revenue from each truck at each milestone. Hess Trucks can recognize revenue at shipments as accrued revenue, regardless of whether they bill monthly or once a year.
Janice owns a bakery that pays a monthly rent of $500. She pays the rent from the previous month on the first day of the new month, meaning the landlord does not receive their payment until their “services” have been completed.
Come the conclusion of the year, the landlord will only have 11 payments from Janice, seeing as the final payment for the last month of the year will come in the new year. Since the landlord has provided the services in the previous year that would elicit the payment from Janice, they represent the transaction in the journal entry by debiting the accrued revenue account and creditign the revenue account in the accounting books.
A consulting company provides its services to clients by charging on an hourly basis ($10 per hour). In March of 2020, they had already provided 200 hours of service. The consulting firm was expecting to reach $10,000 worth of consulting hours by May of 2020.
Therefore, the consulting firm records the accrued revenue in their books for March as $2,000 for those 200 hours, even though the client had not yet been billed for the same amount. Come May, the company will be sent the full invoice of $10,000.
The Evil Twin of Revenue Accrual: Deferred Revenue
Deferred revenue is financial documentation practice that is the opposite of revenue accrual: customers pay in advance but the seller does not provide services or goods yet.
Thus, the seller initially records the received payment as a liability and later converts the entry into a sale when the transaction is completed. Easy as pie.
But sometimes it isn’t, and that’s where SaaSOptics comes in. We have a whole host of resources for companies that want more information on things like revenue accrual. Check out our eBook or our SaaSpedia for more!