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Adjusting: Accrued Revenues

🎯 Learning Objectives

  • Understand what accrued revenue is and when to record it
  • Distinguish between accrued revenue and accounts receivable
  • Record adjusting entries for accrued revenues and expenses
  • Calculate accrued interest on receivables and payables
  • Apply revenue recognition and matching principles to accruals

📚 Background & Principles

Accrued revenue represents services performed or goods delivered but not yet billed or recorded. Accruals ensure revenues are matched with the period when earned.

Core Principle: Revenue must be recognized when EARNED (service performed or product delivered). If work is done but not recorded, an accrual is needed to ensure proper matching.

Accruals can relate to both revenues and expenses. For revenues, we record what we've earned but not yet billed. For expenses, we record what we've incurred but not yet paid.

💡 Key Insight: Accruals ensure financial statements reflect economic reality rather than just cash movements. They're essential for accurate profit measurement under accrual accounting.

🔑 Key Concepts

Accrued Revenue

Revenue earned but not yet recorded in accounting records. Requires adjusting entry at period-end.

Accrued Expenses

Expenses incurred but not yet paid. Recorded as expense and liability initially, then settled.

Accounts Receivable

Asset representing amounts owed by customers for services already provided. Source of accrual adjustments.

Accrued Interest

Interest earned on notes receivable or accumulated on interest payable, not yet recorded in financial statements.

🔍 Deep Dive

Explore accrued revenue and expense concepts at different levels of depth:

🟢 Foundational Level

Understanding basic concept of accrued revenue through freelance designer analogy.

Earn Now, Bill Later

Analogy: The Freelance Designer

Imagine you are a web designer.

The Work (Dec 20-31):

You finish a website for a client. You put in the hours. You EARNED it.

The Invoice (Jan 2):

You don't send the bill until next week.

The Gap:

On Dec 31, if you don't record this, your revenue for the year is too low. You have an asset (right to receive cash). We call this Accrued Revenue.

Recording the Accrual

Scenario: At Dec 31, you performed $5,000 of unbilled work. How do you record it?

Initial situation:

Work completed, earned, but not billed. Need to recognize revenue properly.

Accrued entry logic:

Accounts Receivable (asset) increases, Service Revenue (revenue) increases. Both on SAME side (debit).

Wait, that's both debits...

You're increasing both an asset (AR) and revenue? That would double-count revenue in January.

Correct approach:

Debit Accounts Receivable $5,000 (increase asset), Credit Service Revenue $5,000 (increase revenue). Asset up, revenue up, equity up. Equation balanced.

🟡 Standard Level

Understanding accrued expenses and interest receivable with detailed examples.

Accrued Expenses

Scenario: Employees worked Dec 23-31, earning $4,000. Payday is Jan 5. Accrue at Dec 31.

Adjusting entry (Dec 31):

Debit Salaries Expense $4,000, Credit Salaries Payable $4,000

Effect:

Salaries Expense: $4,000 (properly matched to December), Salaries Payable: $4,000 (liability)

Payment entry (Jan 5):

Debit Salaries Payable $4,000, Credit Cash $4,000

Result:

Salaries Payable: $0 (cleared), Cash reduced by $4,000. Total Salaries Expense remains $4,000 (not adjusted again).

Accrued Interest Receivable

Scenario: Lent $10,000 on Nov 1 at 6% annual interest. Year-end is Dec 31. Accrue interest for 2 months.

Calculate interest earned:

$10,000 × 6% × (60 days ÷ 360) = $100

Adjusting entry (Dec 31):

Debit Interest Receivable $100, Credit Interest Revenue $100

Effect:

Interest Receivable (asset) increases by $100, Interest Revenue increases by $100. Both asset and revenue increase (both debits).

🔴 Advanced Level

Complex accrual scenarios and reversing entries in subsequent periods.

Reversing Accrued Entries

Scenario: You accrued $1,200 salaries at Dec 31 (as above). In January, you pay these salaries. Now you need to reverse the accrual.

Original accrual (Dec 31):

Debit Salaries Expense $1,200, Credit Salaries Payable $1,200

Payment in January:

Debit Salaries Payable $1,200, Credit Cash $1,200

Reversing entry (Jan 31):

Debit Salaries Payable $1,200, Credit Salaries Expense $1,200

Why reverse?

Without reversing, when you record January salaries, you'd double-count $1,200. Original expense remains $1,200 (matched to December), but you'd add another $1,200 for January = $2,400 total expense. Reversing ensures only January expense is recorded.

Partial Period Accruals

Scenario: Pay rent quarterly ($3,000 per quarter), but quarter spans from Nov 15 to Feb 14. How to handle Dec 31 adjusting?

Analysis:

Nov 15 - Nov 30: 45 days in Q4 = $1,500 accrued

Dec 1 - Dec 31: 31 days in Q4 = $3,100 incurred

Adjusting entry approach:

Option 1: Accrue full quarter ($4,600) as of Dec 31, then reverse unused portion ($1,500) in January

Option 2: Accrue only incurred portion ($3,100) as of Dec 31

Professional choice:

Option 1 is cleaner but requires reversing entry. Option 2 matches expense to actual usage. Most accountants prefer matching actual usage.

🎨 Interactive: Accrued Interest Calculator

If you lend money to others (Notes Receivable), interest builds up over time. Calculate the interest receivable.

Interest Receivable Calculator

ACCRUED INTEREST REVENUE
$100.00

🚫 Common Misconceptions & Professional Tips

❌ Misconception 1: "Accrued revenue means we already billed the customer."

✅ Reality: Accrued revenue can be for unbilled work OR billed work not yet delivered. The key is that the service is PERFORMED, not whether billing occurred.
❌ Misconception 2: "Accrued expenses should be recorded when we plan to pay them."

✅ Reality: Accrued expenses are recorded when INCURRED (when service is received or benefit enjoyed), not when paid. Matching principle requires expense recognition in the period it helps generate.
❌ Misconception 3: "Reversing entries are optional and can be skipped."

✅ Reality: Reversing entries are REQUIRED after accruals are settled to prevent double-counting. Without reversing, you'd record the expense or revenue twice.
💡 Professional Tip #1: Always document the reason for accruals. Why is revenue not yet recorded? Why is expense not yet paid? This creates audit trail.
💡 Professional Tip #2: Calculate accruals based on reasonable estimates. For partial periods, estimate proportionally based on time elapsed.
💡 Professional Tip #3: Review accrued balances at each period-end. Large accrual balances that never settle may indicate billing or payment issues.

🧠 Memory Aids & Quick Reference

⚡ Quick Recall: Accrued Revenue Entry

Earned but unbilled: Debit Accounts Receivable (+Asset), Credit Service Revenue (+Revenue)

Subsequent billing: Debit Cash (+Asset), Credit Accounts Receivable (-Asset)

📊 Accrued Revenue

Revenue earned but not yet recorded. Asset and revenue both increase (debit).

📉 Accrued Expense

Expense incurred but not yet paid. Expense and liability both increase (debit).

🔄 Reversing Entry

Opposite of original accrual. Prevents double-counting in next period.

📈 Accrued Interest

Principal × Rate × Time. Increases Interest Receivable asset and Interest Revenue.

📖 Glossary

Accrued Revenue

Revenue earned from services performed or goods delivered but not yet recorded in accounting system.

Accrued Expense

Expense incurred but not yet paid. Initially recorded as expense and liability, then settled.

Accounts Receivable

Asset representing amounts owed by customers for services already provided or goods delivered on credit.

Interest Receivable

Accrued interest on notes receivable. Recognized as Interest Revenue but not yet received as cash.

Reversing Entry

Journal entry that reverses an accrual from previous period to prevent double-counting when actual transaction occurs.

Deferral

Adjusting entry that postpones recognition to future period when cash has already changed hands.

Accrual

Adjusting entry that recognizes revenue or expense in current period for items earned or incurred but not yet recorded.

🎯 Final Knowledge Check

Test your understanding of Accrued Revenues & Expenses:

Question 1: When services are performed in December but not billed until January, what is the December 31 adjusting entry?



Question 2: When employees work Dec 23-31 but are paid Jan 5, what is the December 31 adjusting entry?



Question 3: What is the purpose of a reversing entry after an accrual?