Define accrued revenue and earned revenue clearly and correctly
Many people can repeat the phrase “accrual accounting,” but far fewer can confidently define accrued revenue without hesitation. The same goes for earned revenue. The terms sound similar. They are closely related. Yet they describe slightly different ideas within the broader framework of revenue recognition.
In this guide, we’ll break everything down in plain English. We’ll explain how revenue is recognized, how accrued revenue is recognized, how it appears on the income statement and balance sheet, and why the timing of cash flow does not control the accounting outcome.
The foundation: revenue recognition under GAAP
Under generally accepted accounting principles GAAP, revenue is recognized based on performance. The key rule is simple:
Revenue is recognized when a company has satisfied its performance obligation by delivering the product or service.
This rule is known as the revenue recognition principle. It works alongside the matching principle, which states that expenses should be recorded in the same accounting period as the revenue they help generate.
The goal is accuracy. Financial performance should reflect real economic activity during a specific period, not just when payment is received.
What is earned revenue?
Earned revenue refers to revenue that a company has earned by providing a good or service during an accounting period. The work has been completed. The performance obligation has been satisfied.
If a consulting firm finishes a report for a client, that revenue is earned revenue. It does not matter whether the client pays immediately or in 30 days.
The income statement reports earned revenue for a specific period. That is how financial performance is measured.
Notice something important: earned revenue focuses on the work performed. It does not focus on billing. It does not focus on cash.
Define accrued revenue in simple terms
Now let’s clearly define accrued revenue.
Accrued revenue is revenue that has been earned but not yet received in cash and often not yet billed.
It represents revenue that must be recorded because the company has already provided the product or services, even though payment is received later.
Another way to think about it:
- Revenue is earned.
- Cash has not yet arrived.
- An asset must be recorded.
That asset is typically accounts receivable.
How to record accrued revenue
When you record accrued revenue, the journal entry reflects that revenue is recognized even though no cash flow has occurred yet.
The entry looks like this:
- Debit: Accounts Receivable
- Credit: Revenue
On the income statement, revenue increases. On the balance sheet, assets increase.
This ensures that revenue is recognized in the proper accounting period, rather than waiting for payment is received.
Accrued revenue vs unearned revenue
It is common to confuse accrued revenue with unearned revenue. They are opposites.
Accrued revenue means the work is done but cash has not yet been collected. Unearned revenue means cash has been collected but the work is not yet done.
| Category | Accrued Revenue | Unearned Revenue |
|---|---|---|
| Status of work | Work completed | Work not completed |
| Status of cash | Cash not yet received | Cash already received |
| Balance sheet impact | Asset | Liability |
| Revenue treatment | Revenue is recognized | Revenue not yet recognized |
This distinction is central to proper revenue recognition.
Example: service performed before billing
Imagine a software development company working on a $50,000 contract. By the end of the accounting period, 40% of the project is complete.
Under GAAP, revenue is recognized based on performance. That means $20,000 of earned revenue must be recorded.
Even if the invoice has not yet been sent, the company must record accrued revenue. The income statement shows $20,000 of revenue. The balance sheet shows $20,000 in accounts receivable.
When payment is received later, cash increases and accounts receivable decreases. No additional revenue is recorded at that time.
Accrued revenue in long term projects
Accrued revenue is especially common in long term projects. Construction firms, consulting firms, and enterprise software companies often recognize revenue gradually over time.
In these situations, revenue is recognized based on progress toward completion. This approach ensures that financial statements reflect actual performance during each accounting period.
Without accrued revenue, income statements would show large spikes only when invoices are sent or payments are received. That would distort financial performance.
Impact on financial statements
Accrued revenue affects multiple financial statements.
- Income statement: increases revenue and net income.
- Balance sheet: increases assets through accounts receivable.
- Cash flow statement: does not increase operating cash flow immediately.
This explains why profit and cash flow can differ. A company may report strong earnings while still waiting to collect payment.
Why correct revenue recognition matters
Revenue recognition is one of the most scrutinized areas in accounting. Investors, lenders, and auditors pay close attention.
Overstating accrued revenue can inflate earnings. Understating it can make performance look weaker than it truly is.
Accurate reporting ensures:
- Reliable financial performance metrics
- Clear visibility into company health
- Proper application of GAAP standards
- Trust from external stakeholders
Common errors businesses make
- Recognizing revenue before delivering the product or service
- Confusing invoiced revenue with earned revenue
- Failing to adjust accruals when estimates change
- Ignoring collectibility risks in accounts receivable
Revenue must be recognized based on performance. Billing schedules do not override accounting principles.
Final clarification
To summarize:
- Earned revenue is revenue generated by delivering a good or service.
- Accrued revenue is earned revenue that has not yet been collected in cash.
- Revenue is recognized in the period the work is performed.
- Cash timing does not control recognition under GAAP.
Once you understand these relationships, financial statements become much easier to interpret. The income statement shows what was earned. The balance sheet shows what is owed. The cash flow statement shows when money actually moved.