Study: Accrued Revenues: Cash is Received AFTER Revenue is Recognized
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Slides 1-4 (1m:10s)
Links to an external site.Welcome to Introduction to Accounting Preparing for a User’s Perspective
Accrued Revenues: Cash is Received AFTER Revenue is Recognized
Slide 2
Here are the criteria for revenue recognition. I won’t take the time to read them, you can do that on your own.
Slide 3
This is also a review of the three common revenue recognition situations from prior videos. What we will talk about today is how cash is received AFTER the revenue is recognized and that that will result in an accrued revenue and you will often see an account called an account receivable.
Slide 4
The difference between deferred revenues and accrued revenues is the timing of the cash flows in relation to when revenue is recognized.
Slides 5-7 (3m:53s)
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Example: On 5/1/X1 Lender Co. lent Borrower $10,000 for 12 months at 12% simple interest with interest and principal to be paid on 4/30/X2. Per accrual accounting, record all required entries for Lender Co. on May 1st, X1, December 31st, X1 and April 30th, X2.
Per the revenue recognition principle, WHEN should the interest revenue be recognized?
Let’s diagram this out. The loan is given out on May 1st and then it’s to be repaid with interest April 30th of the following year, that’s a 12 month period. The math for computing interest is the Principal, which is the $10,000 loan, times the annual interest rate of 12%, and the time period that this interest is running for the whole loan is 12 months out of a 12 month [annual] interest rate period. So that would be $1,200 per year, per 12 month period.
The problem is that year [of interest] straddles two accounting periods assuming this company has a December 31st year end. So, how much of this $1,200 should be [recognized] in X1 and how much should be [recognized] in X2. That math is also pretty easy.
It’s $1,200 per year or 12 months, if you divide that $1,200 per year by 12 months, you get $100 per month; therefore, in X1, we have 8 months, resulting in $800 of interest [$10,000 Principle * 12% annual interest rate * 8/12ths of the year]. The math is 8/12ths of a year, 8/12ths of this $1,200 [full year of interest] gives us $800.
The following year it’s 4/12ths of a year for $400 [$10,000 Principle * 12% annual interest rate * 4/12ths of the year].
In total it comes out to the $1,200 interest revenue.
Now what we’re going to do is do the journal entries to make sure we recognize revenue of $800 in X1 and recognize revenue of $400 in X2. This [$800 of interest recognized in X1] will be an accrued revenue because we won’t receive the cash until the following year.
Slide 6
On May 1st, X1 Lender Co. gave out [lent out] cash of $10,000, credit to cash. In exchange, it has a note receivable of $10,000 debit to note receivable. As of December 31st, it needs to accrue the interest revenue for the amount its earned even though it hasn’t been paid yet.
How much should it accrue? Credit interest revenues $800. Now the question is, “Did we receive the cash?” and therefore [we should] debit cash? The answer is no we didn’t, so we have a[n interest] receivable debit $800.
We can then post that to the interest receivable ledger winding up with a debit to interest receivable at the end of the year of $800. In the future we should collect this $800 in cash.
Next year, X2, on April 30th, Lender receives a total payment from the borrower of $11,200. Why did they receive that $11,200? Let’s break it out piece-by-piece.
First off, they earned another $400 of interest revenue, credit to interest revenue of $400 and it received back all $10,000 of the principal it lent out, so credit to notes receivable, $10,000.
The difference here [between the cash received of $11,200 and the sum of interest revenues recognized of $400 and the note receivable principle of $10,000] is $800, and surprisingly enough you will see it exactly matches interest receivable, so we simply had an asset, which was a debit of interest receivable last year, and now we credit the interest receivable in X2, because we have now received it in cash.
When we post these to the general ledger, we credit interest receivable $800. So at the end of X2, we have no more receivables.
Slide 7
Now let’s step back and look at it, did we get the interest revenue recognized in the correct accounting periods?
In X1, we recognized $800 of interest revenue. In X2, we recognized $400 of interest revenue.
Do our recognized revenues comply with the revenue recognition principle?
If you look at the timing in our diagram from before, we should that $800 [of interest revenue] should have been [recognized] in X1, and $400 [of interest revenue] should be [recognized] in X2, for a total of $1,200 over the 12 month period, and, “YES” we did comply [with the revenue recognition principle].
Slides 8-10 (2m:00s)
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Here’s another example.
Example: On 11/28/X5 Consultant A provided $4,000 of consulting services to New Co. on account. New Co. paid Consultant A all $4,000 on 1/4/X6. Record all required entries AND adjusting entries for 20X5-20X6 as per the revenue recognition principle.
Per the revenue recognition principle WHEN should the consultant recognize the revenue?
The work was done November 28th, X5. So, $4,000 of revenue should be recognized, but no cash is received yet; therefore, this is an accrued revenue.
January 4th of the following year, cash is received so $4,000 of cash is received BUT NO revenue should be recognized in X6.
How do we do the accounting?
Slide 9
On November 28th, X5, the work is done, so we credit consulting revenue for $4,000 and since we didn’t get paid yet, you would have to debit accounts receivable $4,000.
We post that to the accounts receivable ledger, debit $4,000, resulting in an ending balance at the end of X5 of a $4,000 debit in accounts receivable. No adjusting entry is needed in X5.
Then we jump to X6 when the payment is actually received. Debit to cash of $4,000, but we can’t credit revenue because we already recognized revenue in the prior year. You can’t recognize revenue again because then you would be double-counting. So all we are going to do here is collect this receivable by crediting accounts receivable $4,000.
When you post that to the ledger, credit $4,000, the ending receivable at the end of X6 is $0, as it should be.
Slide 10
Stepping back and looking at the big picture. On November 28th, we recognized consulting revenues of $4,000 even though cash was not received. On January 4th of the following year, we recognized no revenues, but we did receive cash. $4,000 of cash received BUT NO revenue recognized.
Did we handle that [the revenue recognition principle and related accounting] correctly? Yes, we did.
Slides 11-12 (0m:41s)
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Slide 12
I hope this has helped you better understand accrued revenues and I wish you all the best on the quiz
Aloha.