How to Receive Revenue On Your Books Before Earning It
Revenue is at the center of all businesses. Without it, you wouldn’t have a business, so accounting for that revenue is an essential part of the process.Â
However, receiving revenue isn’t always clear-cut. While you’re likely to receive the money immediately after providing goods, this isn’t always the case for service-based businesses.
For example, a construction contractor will likely only receive their payment after the work has been completed or at specific milestones as the project progresses.
In these cases, how do you go about recording revenue?
The revenue recognition principle is where revenues are recognized on the income statement in the period when realized and earned—not necessarily when the money is received. Let’s dive deeper into the details.
Which Events Trigger Revenue Recognition?
If you refer to the generally accepted accounting principles (GAAP), two events allow revenue to be recorded:
- A critical event must trigger the transaction process.
- The cash that results from the transaction must be measurable within a certain degree of reliability. In other words, the buyer must submit funds that match the cost of goods or services.
Earning Vs. Receiving Revenue
A critical event is very straightforward. If you go into a store to buy a new laptop, the critical event is when you take the laptop to the cashier, and they scan the barcode for purchase. The transaction is complete when you hand over the money. In this case, the store owner has earned and received the money all in one go.
A more complex situation is if you hire an electrician to carry out some work on your house. They then complete the work (earn the revenue), but you don’t pay them until they give you the invoice (receive the revenue).
In this case, there is a lag between when the electrician carries out the work (earning the revenue) and when they’re compensated for it (receiving the revenue). However, as soon as the revenue has been earned, it can be recorded as such. When the money gets paid, it won’t be recorded as revenue because the electrician already did that.
Can You Record Revenue Before You’ve Earned it?
Often, businesses require an upfront payment or deposit for their goods or services. This is called “deferred revenue.” What’s important to understand is that even though you may have the cash sitting in your bank account, it may NOT be recorded as revenue until the buyer has received what they paid for.
For example, you provide a software service to your clients that requires an upfront payment of $1,500. It takes three weeks for the software installation to complete so the client can use it.
Only after you have completed the installation and the software is operational will you have earned your revenue. That means the $1,500 can finally be recorded as revenue.
While it’s tempting to record monies received as revenue before the transaction has been completed, it’s a big accounting no-no. Unless you fancy landing yourself in hot water the next time you face an audit, never record revenue until you’ve actually earned it.
Are There Any Exceptions?
Like most complex things, there are some exceptions to the rule:
Payment by Installments
Large purchases are typically paid for in installments. The most famous example here would be repayments on a mortgage or for a car.
For installments, the revenue can only be recorded as each payment is received. For example, you purchase a car for $100,000. Payment for the car is via 100 monthly installments of $1,000.
As you make each payment, the revenue is recognized as a percentage of the total amount of the sale. In this case, it would be 1% per installment.
Long-Term Contracts
Projects that span a long time – often years – are typically split into milestones or stages. As each stage is completed, a payment is made, and it can then be recognized as revenue.
For example, a contract for a new highway construction project that promises to deliver 100 miles of road is worth $5 million. For every ten-mile segment of the highway that’s completed, a payment of $500,000 will be made. As each payment is received, the revenue will be recorded.
You’ll note that in both cases above, the revenue still cannot be recognized until it has been earned.
How to Record Revenue Once Earned
All revenue earned can be recorded in the general ledger. You can generate an income statement for the desired period from this document.
One potential pitfall for recording revenue before you’ve received the payment is that it can make your company look more cash-rich than it actually is. While it looks great on paper, it can pose a problem if you’re still waiting for most of it to be paid in.
Keep a tight reign on your cash flow statements to avoid this problem. This will allow you to understand how liquid your company is and, more importantly, whether or not you can pay your bills.
Sounds Complicated. Who Can Help?
We get it. Getting to grips with finances is a pain in the proverbial, and you’d rather be out there making sales, not recording them. That’s why we always recommend getting the assistance you need to get the job done properly.
At Finvisor, our virtual accountants are on hand to do just that. They can take care of all your revenue recognition and recording and keep tabs on your cash flow too. Best of all, you only pay for what you need making it an affordable option, no matter how big or small your business is.
If you’re struggling to understand the ins, outs, and intricacies of accounting, why not get in touch with Finvisor today to see how we can assist you? We make finances easy so you can get on with running your business.
To learn more about what we do, or to request a quote, contact us at hello@finvisor.com or 415-416-6682. We’re here to help you navigate deferred revenue journal entries so you can make the most of your assets!
*This blog does not constitute solicitation or provision of legal advice and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.*
- Last Modified
- April 4, 2024
FOR ANY QUESTIONS
CONTACT US
- MAILING ADDRESS
Finvisor HQ
48 2nd St, 4th Floor
San Francisco, CA 94105
- PHONE NUMBER
- EMAIL ADDRESS
"*" indicates required fields
