Accrued and Deferred Revenue: Timing Differences on Both Sides

Accrued revenue is revenue a business has earned and not yet billed, so it is an asset: the work is done and money is owed for it. Deferred revenue is cash a business has taken before doing the work, so it is a liability: goods are owed. The two are mirror images of the same timing gap, and each clears when the missing half of the transaction happens.

Here is what sits underneath that. A sale is really two separate events that a business tends to treat as one: the moment the goods reach the customer, and the moment the money reaches the bank. Most of the time those two events fall close enough together that nobody notices they are different. But an accounting year has to end on a particular date, and every year that date lands in the middle of some transactions rather than between them. When it does, one half of the sale sits inside the year and the other half sits outside it. The balance sheet is where the stranded half waits.

Two dates alone settle which of the two items a transaction produces, and the side of the balance sheet follows from those dates rather than from convention. Anjani Stationers holds one of each at the end of year two: Rs 4,00,000 of school money taken before any notebook was delivered, and Rs 2,50,000 of notebooks delivered before any bill was raised.

What is accrued revenue, and when does it appear?

The shape is easiest to see when the amounts are small, so think about a tailor for a moment. A wedding order goes out on the thirtieth of the month, carried to the house, unpacked, checked and accepted. The tailor is busy with the next order and writes up the bill on the third of the following month. Ask the obvious question: in which month did the tailor earn that money? The answer everybody gives without hesitating is the month the clothes were delivered, and that answer is also the accounting answer. The bill is paperwork. The earning happened when the goods changed hands.

Accrued revenue is the amount owed to a business for work it has genuinely completed but has not yet invoiced, and it is an asset because the business is now a step ahead of its own paperwork rather than behind it. The two conditions have to hold together. Something must have been delivered or performed, and controlThe point at which the customer can use the goods, keep them, sell them on or refuse to return them. Control passing is what separates a completed sale from a promise to sell. of it has passed to the customer. And no invoice can yet exist for it, so the amount cannot sit in the ordinary bills-outstanding column. A business that has merely promised to deliver has earned nothing, so take away the first condition and there is nothing to record at all. Take away the second and the item is simply a normal trade receivableThe ordinary amount a customer owes against an invoice that has already been raised. The amount sits under trade receivables on the balance sheet and starts ageing from the invoice date. like any other.

The word attached to this on a set of accounts is unbilledWork that has been done and not yet invoiced. An unbilled amount is real and owed, but there is no bill number attached to it yet, so it cannot appear in an ageing report or be chased by the collections desk.. Unbilled revenue, unbilled receivables, revenue accrued but not due: the labels vary between businesses, and all of them point at the same thing, a completed sale carrying no invoice number. An amount with no invoice number cannot be chased, and that matters more than the label suggests. An unbilled amount does not appear in a receivables ageing report, the collections desk cannot ring anybody about it, and in many businesses it is the quietest place for money to sit.

Anjani Stationers has exactly one such item at the end of year two. In the last week of March a lorry left the godown carrying five thousand exercise notebooks for the Sunrise Public School group, agreed at Rs 2,50,000, and the school's storekeeper signed for them at the gate. The billing desk raised the invoice on the third of April. The books close on the thirty-first of March. So on the day the accounts were drawn up, Anjani Stationers had delivered the notebooks, earned the Rs 2,50,000, and had nothing to show for it in the invoice book. The Rs 2,50,000 is accrued revenue, it belongs to year two, and it is an asset. The amount sits inside the published Rs 95,00,000 of gross receivables rather than being added on top of it.

What is deferred revenue, and why does cash alone not make a sale?

Now turn the order of events around. A wedding caterer takes an advance in January for a function in April. The money is in the bank, and it is unmistakably the caterer's money in the sense that nobody else can spend it. But the caterer has not cooked anything. If the hosts call off the wedding in February, that advance goes back. The caterer is not richer in January; the caterer is committed in January.

Deferred revenue is cash a business has already collected for goods or services it has not yet provided, and it is a liability because what the business owes in exchange is delivery of the goods, not repayment of the money. This is the item that catches people out, and the reason it catches them is that money arriving feels like a sale being made. It is not. Under accrual accounting a sale is recorded when the customer gets what was promised, and no earlier. Cash arriving ahead of that moment is a fact about the bank account and not a fact about the profit statement. The two facts have to be recorded separately, so the cash goes into the bank balance and an equal and opposite obligation goes onto the other side of the balance sheet, where it waits.

The name a set of accounts is most likely to use for it is a contract liabilityThe formal name for an amount a business has been paid, or has an unconditional right to be paid, before it has delivered what the customer bought. Deferred revenue, unearned revenue and advances from customers all describe the same balance.. Deferred revenue, unearned revenue, advances from customers and income received in advance are all the same balance wearing different labels, and any of them can turn up depending on how the accounts are presented. Every one of them means the same three things: money in, goods out still pending, and revenue not yet recorded.

Anjani Stationers has Rs 4,00,000 of it at the end of year two. The Sunrise Public School group is both its largest customer and its slowest payer. The school group placed and paid for a pre-season order for the coming school year, and those notebooks had not been delivered when the books closed. The effect of the Rs 4,00,000 is narrow. The bank balance goes up by Rs 4,00,000. The contract liability goes up by Rs 4,00,000. Revenue for year two does not move at all: it stays at Rs 2,70,00,000, exactly where it was. Two lines of the balance sheet changed and the profit statement was not touched. No clearer way exists to see that taking money is not the same event as making a sale. The direction of travel matters too: the same balance was Rs 2,00,000 a year earlier, so it has doubled while revenue grew 12.5 per cent.

Why does one sit as an asset and the other as a liability?

There is a rule underneath this and it is short enough to carry around. Look at the two events that make up any sale, delivery and payment, and ask which one happened first. Whichever event ran ahead, the other party is now behind, and the balance sheet records who is behind. If the business delivered first, the customer is behind and owes money, so the business holds an asset. If the customer paid first, the business is behind and owes goods, so the business holds a liability.

The side of the balance sheet an item lands on is not a convention to be memorised: it follows directly from which of delivery and payment ran ahead of the other on the day the books closed. Nothing else decides it. Not the size of the amount, not whether the customer is reliable, not whether the business is having a good year. Two events, one order, and the order is the answer. Asked in that form, the question never confuses the two items, and it also explains why a business can quite normally hold both of them at once against the very same customer, as Anjani Stationers does with the Sunrise Public School group.

A set of accounts sometimes shows three lines rather than two, and one more distinction explains why. When the business has delivered and the amount is still unbilled, raising the bill is still to happen, so the right to be paid is not yet unconditional. When the bill has gone out, that right becomes unconditional and the item moves into ordinary trade receivables. Formal accounts often call the first of those a contract assetA right to payment that still depends on the business doing something further, such as raising the bill or completing another part of the order, rather than only on time passing. Once it depends on nothing but time, it becomes an ordinary receivable. and the second a receivable, and both are assets. There is only one way for the customer to be ahead, so the liability side has only one line.

How does a receivable differ from deferred revenue?

Accounts Receivable vs Deferred Revenue: the same customer, two opposite obligations

A receivable and deferred revenue get muddled more often than any other pair on a balance sheet, and the reason is understandable. Both of them are created by a customer. Both of them appear because a sale has been agreed and not fully completed. Both of them sit on the balance sheet rather than the profit statement. And in Anjani Stationers' case, both of them are attached to the same school group. So the question a reader has to be able to answer quickly is not what they have in common but what separates them.

A receivable is money the customer owes to the business. Deferred revenue is goods the business owes to the customer. The reversal drives every other difference between the two. Follow it through and everything else falls out. A receivable is settled when the customer pays, so it turns into cash. Deferred revenue is settled when the business delivers, so it turns into revenue and no cash moves at all on the day it clears. A receivable already had its revenue recognised, back when the goods went out. Deferred revenue has had none recognised, and that is exactly what it is waiting for. A receivable carries the risk that the customer never pays, and a provision for doubtful debtsAn amount set aside against receivables the business no longer expects to collect in full. The provision reduces the receivables figure carried on the balance sheet without waiting for the debt to formally fail. exists to deal with that risk. The money behind deferred revenue is already in the bank, so deferred revenue carries no such risk. Deferred revenue carries a different risk, the risk of not being able to deliver.

The last of those is where the intuition finally clicks. The test is what would happen to each line if the customer disappeared tomorrow. If the Sunrise Public School group closed its doors owing Anjani Stationers Rs 92,50,000 on invoices, that would be a very serious loss. If it closed its doors having paid Rs 4,00,000 for notebooks not yet printed, Anjani Stationers would be holding money it might well have to return, but it would not have lost anything it had already spent making. One line represents money the business is hoping to receive. The other represents money it has already received and now has to earn.

How does each one unwind?

Neither of these items is meant to stay. Both are a balance sheet holding what a single incomplete transaction left behind, and both disappear when the missing half happens. The two disappearances look completely different, and only one of them creates revenue.

Deferred revenue unwinds by delivery and becomes revenue without any money moving. Accrued revenue unwinds by invoicing and becomes an ordinary receivable without any revenue being created. Take the Rs 4,00,000 first. When the pre-season notebooks reach the Sunrise Public School group, three things happen in one stroke: the contract liability falls to zero, revenue rises by Rs 4,00,000, and the bank account does not move at all. The money came in months earlier. Delivery against an advance is the only occasion on which a business books revenue on a day when nothing whatever arrives in the bank, and precisely that fact gets misread as revenue appearing out of nowhere.

Now the Rs 2,50,000. On the third of April the billing desk raises the invoice. The accrued revenue line falls to zero and trade receivables rise by Rs 2,50,000. The revenue was recorded back in March when the notebooks were delivered, so revenue does not move now. An amount already earned has acquired a bill number, and the bill number changes what can be done with the amount rather than what it is worth: it can now be aged, chased and, if it comes to it, provided against. The cash arrives later still, whenever the school pays, and at that point the receivable falls to zero and the bank rises. So the accrued item passes through three states while the deferred item passes through two, and revenue is created at exactly one point in each chain.

What are Anjani Stationers' two timing items?

The two items arrive in front of a reader together, on one balance sheet. At the end of year two, against revenue of Rs 2,70,00,000, Anjani Stationers carries a contract liability of Rs 4,00,000 and, buried inside its receivables, Rs 2,50,000 of unbilled deliveries. Both concern the Sunrise Public School group. Both exist only because 31 March fell in an awkward place. And they point in opposite directions.

The Rs 2,50,000 of accrued revenue does not add to the published Rs 95,00,000 of gross receivables. The accrued amount is one of the components of the total, and the right reading is Rs 92,50,000 of invoiced bills plus Rs 2,50,000 not yet billed. The alternative reading inflates the balance sheet by an amount nobody owes. The arithmetic runs all the way down. Splitting a total does not change it, so gross receivables of Rs 95,00,000 less the provision for doubtful debts of Rs 9,00,000 gives net receivables of Rs 86,00,000 whether or not the unbilled part is split out.

Rs 2,50,000 and Rs 4,00,000 mean very little on their own next to revenue of Rs 2,70,00,000, so the two amounts need scaling against something. Each converts into days of revenue by dividing by revenue and multiplying by 365. The accrued Rs 2,50,000 is 3.4 days of revenue. The deferred Rs 4,00,000 is 5.4 days. So the whole of the unbilled position is worth about three and a half days of trading, and the advances are worth about five and a half. The same arithmetic shows what the unbilled amount does to days sales outstandingThe average number of days between a sale and the money for it arriving, worked out as receivables divided by revenue and multiplied by 365. The figure is a way of expressing a balance as a length of time.: on the full Rs 95,00,000 the figure is 128.4 days, and on the Rs 92,50,000 of invoiced bills alone it is 125.0 days. The 3.4 day difference is the unbilled amount and nothing else. No cleaner demonstration exists that the Rs 2,50,000 is inside the total rather than beside it.

Three positions of the closing date carry the whole argument. Drag the closing date back to day 40 and the Rs 2,50,000 vanishes entirely. On day 40 those notebooks are still in the godown and there is no sale to record, so only the Rs 4,00,000 liability remains and revenue recognised is nil. Push it forward to day 70 and the asset does not disappear, it changes its name, from accrued revenue to an ordinary trade receivable. The amount and the revenue both stay exactly where they were. Push on to day 85 and the Rs 4,00,000 liability vanishes and revenue jumps from Rs 2,50,000 to Rs 6,50,000 on a day when no money moves at all. Every single one of those transitions is caused by moving one date, and not one of them is caused by anything changing in the business.

Who reads these two lines, and what do they do with them?

Step out of the classroom. Three quite different people open these two lines in the same week, and none of them is admiring the bookkeeping.

A lender reads deferred revenue as work already sold and already paid for, an analyst reads the pair together to explain why cash and revenue disagree, and Anjani Kulkarni reads the unbilled line as money that cannot even begin to be chased. Watch each of them work. The lender's first job is to decide what is actually an obligation to repay, and the answer for the Rs 4,00,000 is that none of it is. There is no interest on it, no repayment date, no lender behind it, and no circumstance short of the order being cancelled in which cash goes back out. The lender instead treats the Rs 4,00,000 as a small pre-sold order book with the money banked, then asks the question that actually carries risk: can Anjani Stationers print and deliver those notebooks on time, given that its godown already holds Rs 28,00,000 of paper and its cycle is lengthening.

The analyst uses the two together as a bridge. Deferred revenue is cash that arrived ahead of revenue, and accrued revenue is revenue that was recorded ahead of any bill, so the two pull in opposite directions and partly cancel. Rs 4,00,000 against Rs 2,50,000 leaves Rs 1,50,000 of net cash-ahead-of-revenue, a shade over two days of trading and a small number in a year where far larger movements were happening in receivables and inventory. Smallness is the useful conclusion: the analyst can now say that the timing items are not what explains the gap between operating cash of Rs 36,30,000 and the profit, and go looking elsewhere.

Anjani Kulkarni's use is the most practical of the three, and it is the one worth copying. She looks at Rs 2,50,000 of work delivered with no bill against it and sees a job half done inside her own office. Until that invoice exists the amount is invisible to the collections desk, does not appear in any ageing report, is not covered by the provision, and cannot be pointed to in a conversation with the school. Everything the business does to get paid starts with the bill. An unbilled amount is not a slow customer, it is a slow supplier of paperwork, and the difference matters because only one of those is something the business can fix on its own by Friday.

Anjani Stationers Private Limited, Chitra Binding Works Private Limited, Anjani Kulkarni, Meera Rao and the Sunrise Public School group are invented.
Educational material. Not advice on any investment, tax, budget or market position.