Your small business may earn revenue in a variety of ways at a variety of times. Although this different avenues of earning are great for your small business, it also leads to unique revenue reporting requirements. It’s a good idea to have a firm grasp of the following rules related to revenue recognition to ensure your accounting procedures are appropriate.
Cash Basis vs. Accrual Accounting
Two methods of accounting exist for revenue recognition: cash basis and accrual basis. The cash basis is simplest, as the rules of revenue recognition for this method stipulate that you recognize revenue when your company receives the payment. For example, if you completed a project three months ago, but you just received payment this month, you would record the payment for the current month because that’s when you actually received the money. This method provides an accurate picture of cash flow, so you might consider using this method if you want to know how much cash your business has at any given point.
The accrual method reports revenue under different rules. Instead of recording the transaction when the money is received, you would record it when the work is completed. These standards give you a clear picture of goods and services sold at any point. You might consider using this method when you want an accurate snapshot of your sales. The accrual method of accounting recognizes the cost of goods sold as an expense at the time of sale. This ensures the revenues and expenses for a period tie to the same activity.
Accrual Process Accounting Entries
An accrual for revenue occurs when you provide a service or a good, but you haven’t collected the revenue yet. In this case, the revenue is both earned and recognizable. A journal entry is made that recognizes revenue as the credit portion of the entry, and an accounts receivable accompanies all accrued revenue entries. This is because all accrued revenue is yet to be paid, so your small business has a legal claim to receive payment.
In some situations, you might collect payment in advance of providing a good or service to your clients. For instance, you may agree to supply a company with six months of booking services for $6,000. If the company pays all six months upfront, you have revenue not yet earned because the work hasn’t yet been performed.
Under accrual accounting, you establish a liability account because you now have an obligation to perform the agreed upon work. Only when your company performs the work do you move the balance in the liability account into a revenue account. Keep in mind that the liability account is typically titled as unearned revenue. Therefore, you initially record all $6,000 on the balance sheet as unearned revenue. After completing one month of services, your unearned revenue account, which is a liability, reduces to $5,000, and your service revenue account now reports $1,000.
When you’re a small business owner, you want to make sure that you properly record transactions, no matter which revenue recognition concept you choose. 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.