Accrued vs. Deferred Revenue
Accounting for revenues as a deferred or accrual situation is important to properly recognize income in the correct period.
- 1 The Difference Between Accrued Revenue Accounts Receivable
- 2 How Is Deferred Revenue Connected to Accounts Receivable?
- 3 What Is the Difference Between Accruals Deferrals?
- 4 What Is the Difference Between Prepaids Accruals?
Don’t worry — you’re not the only one confused by accounting terminology. Accrued and deferred revenue both relate to the timing of transactions, which are recognized when they occur, not when money changes hands. Allocating revenues to the proper period is a cornerstone of the accrual method of accounting, which is the approved method according to generally accepted accounting principles, also known as GAAP.
Accrued revenues are used for transactions in which goods and services have been provided, but cash hasn’t yet been received. In many cases, these revenues are included in the accounts receivable listing, and accountants don’t need to look for them or to book them separately. A common accrued revenue situation is interest that has been earned but not yet received. The journal entry is to debit (increase) interest receivable, an asset account, and to credit (increase) interest revenue, which is reported in the income statement. When the interest is received, the entry is to debit cash, increasing it, and to credit interest receivable, zeroing it out. The end result is to recognize the revenue in the income statement before the money is actually received.
Deferred revenues reflect situations in which money has been received, but goods and services haven’t been provided. These revenues are also known as deposits, and they are not recognized as revenues in the income statement. Deferred revenues are not real revenues — they don’t affect net income or loss at all. Rather, they report on the balance sheet as liabilities. The journal entry to recognize a deferred revenue is to debit (increase) cash and credit (increase) a deposit or another liability account. When services or goods are provided, the entry is to debit (decrease) the deposit account and credit (increase) the revenue account — the real one, which reports in the income statement and impacts net income or loss.
Many businesses are not set up to recognize accrued and deferred revenues, as they happen. A common scenario is for accrued revenue to be ignored, and deferred revenue to be recognized as a regular revenue. Both situations are corrected by adjusting journal entries at the end of a period, as part of the closing process. As accrued revenues are discovered, they are entered in the system. Revenue accounts may be reviewed to be sure there are no deposits that need to be moved out into the liability account. The journal entry to correct this problem is to debit (decrease) regular revenue and (credit) increase a deposit or other liability account.
When considering cash flows, there are differences between deferred and accrued revenues. Deferred income involves receipt of money, while accrued revenues do not — cash may be received in a few weeks or months or even later. When you see a revenue listed in the income statement, it doesn’t mean that money was received — cash could have been received earlier or later. Another consideration when using deferred and accrued revenue is that these are not one-time processes. Once a deferral or an accrual account is charged, you need to clear it up — these accounts are not static, and if you see these numbers never changing, most likely there are errors that need to be corrected.