Have you ever wondered what the difference is between deferred revenue vs accrued revenue? If so, you’re not alone. Many people get confused by these terms, but it’s actually quite simple once you understand the basics. Here’s a quick rundown of each.
Deferred Revenue: This is money that has been earned but not yet received. For example, if you sell someone a product on January 1st but don’t deliver it until February 1st, then the sale would be considered deferred revenue.
Accrued Revenue: This is money that has been earned but not yet invoiced or billed. For example, if you provide services to a client in December but don’t send them an invoice until January, then the income would be considered accrued revenue.
So now that we know the difference between deferred revenue vs accrued revenue, why are they important? Well, both accrual and deferral have their advantages and disadvantages. Let’s take a look at some of those.
Deferred Revenue vs Accrued Revenue
Deferred revenue is money that has been received but has not yet been delivered. This often happens when companies sell products or services but delay delivering them.
This is not to be confused with accrued revenues, which are money that your company has already earned, but has yet to receive.
This usually happens when a company provides a product or service but does not immediately bill the customer. The client has not paid for the product yet, but the company has delivered it.
Deferred Revenue vs. Accrued Expense: What’s the Difference?
Deferred Revenue is the exact opposite of Accrued Revenue. When a customer pays for something before receiving it, this is called unearned revenue.
The entry of the transaction on the company’s books is a liability for as long as the business has supplied the product or service.
Example of deferred revenue
We see examples of deferred revenue every day.
- When an e-commerce site sells physical products, the customer has to make a payment online before the items are shipped.
- When insurance companies receive premiums for 12 months of coverage
- When contractors accept a portion of the cost upfront and work to complete the project.
- A subscription service charges a customer in advance for a whole year of deliveries, but the customer has not yet received any shipments.
What is Accrued Revenue?
The accrued revenue from a sale is the amount that a seller recognizes as having been earned, but which has not been yet been invoiced or charged to a customer. This amount is used when recognizing revenues for accounting purposes.
When businesses bill for services, they can often take several months before receiving payment. This can result in accounts receivable, which is money owed to the business.
In accounting, accrued revenues refer to money that has already been billed but has yet to be paid. This is most common in the service industry, where clients may delay payments for months at a time.
In manufacturing, accrued revenues are not very common, as most companies issue an invoice as soon as the product has been shipped.
Accrued revenue is a concept that is used to properly match the revenue from sales with the expenses incurred.
If a business does not use accrued revenue, this would give a false impression that the company has low revenue and profits. This would be misleading as it would not take into account any future invoices that have yet to be issued.
As a result, businesses need to include accrued revenue to get a more accurate picture of their financial situation.
If a business does not use accrued revenue, this can result in large fluctuations in its reported revenue and profit. This is because revenues would only be recorded when invoices are issued, which tend to happen at longer intervals. As a result, this can make it difficult to get an accurate picture of the business’s financial health.
On the other hand, accruing revenues smooths out the ups and downs of monthly profits and losses.
Accrual vs. Deferral: Key Differences
Here are some important differences between the two types of accounting systems.
Accruals: Occur before payment or receipts of revenues.
Deferral: Occur after payments or receipts of revenues.
Accrual: Incurred but have yet to be paid (accounts receivable).
Deferral: Paid but have yet to incur expenses (pre-paid accounts).
Accrual: No cash is paid out initially.
Deferral: Cash is paid out in advance.
Accrual: Earned but has not yet been received (accounts payable).
Deferral: Received but not yet incurred (deposit or pre-payment).
Expense vs. Revenue
Accrual: Decrease in expense and increase in revenue.
Deferral: Increase in expense and decrease in revenue.
An accrual system records revenue before it is actually received. A deferral system needs to decrease the debit account to credit revenue.
Your company can save money and time by automating your accounts payable process.
The Importance of Accrual and Deferral
Accounting practices like deferred and accrued revenue are important in making sure expenses and income are balanced.
Understanding accrual and deferred revenue is important for understanding a company’s financials during the period. These methods help to properly match revenue and expenses, and using them consistently provides valuable insights into company operations.
Financial obligations and revenues are important information for a company’s owner or manager to have. This data helps them make important decisions for the future of their company.
By following the guidelines of Generally Accepted Accounting Principles, investors and stakeholders can better assess the health of a business and compare it to its competitors.
Accrual-based accounting systems provide more accuracy than do the cash-basis systems.
A cash basis of accounting provides a snapshot of your current cash on hand but does not show your future expenses or obligations.
On a cash flow basis, expenses are recorded as they’re paid, and revenues are only recognized when money actually changes hands.
The main advantage of accruals and deferrals is that it allows businesses to keep track of all their revenue and expenses for a certain accounting period. This provides them with an accurate financial picture of their business operations during that time.
If companies only tracked their sales when money was exchanged, they wouldn’t have a complete picture of their cash flow.
This form of bookkeeping smooths out a company’s income over a longer period.
While an e-commerce business may look very profitable during the busy holiday season, it can look much less so once the holiday season is over. This is because if a company uses accrual-based accounting, income is reported when it is actually earned, not when it’s paid out. This provides a much clearer picture of the true health of the company.
The accrual and deferred method of accounting for revenue and expenses can provide a clearer picture of a company’s financial situation. Cash-based accounting only recognizes revenues when they come in (during the last quarter), but not the expense of the products you ordered until you pay for them. This can result in a misleading portrayal of the company’s overall profit.
Overall, both revenues have their advantages and disadvantages. It’s important to understand both concepts to make informed decisions about your business finances. Hopefully, this quick overview has helped clear up any confusion you may have had about deferred revenue vs accrued revenue.