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The mysterious double side of accounting: Do you know the difference between accrued revenue and deferred revenue?
In the field of accounting, the revenue recognition principle is a cornerstone. Under this principle, income is deemed earned when it is realized or realizable, even if the cash has not yet been received. This is one of the core concepts in accrual accounting and works together with the matching principle to determine when revenue and expenses are recognized. In this context, accrued income and deferred income have become two important concepts, and their differences have a significant impact on the presentation of corporate financial statements.
Accrued income refers to income that is recognized when an enterprise delivers goods or provides services before cash has been received. Deferred revenue is recorded as a liability when cash is received but goods or services have not yet been delivered.
Definition and examples of accrued income
Accrued revenue means that the company still recognizes the revenue after providing goods or services even though the cash has not yet been received. This usually occurs when a business has fulfilled its obligations and effectively delivered goods or services to customers. Under the framework of accrual accounting, this revenue must be reflected in the financial statements regardless of when the cash is actually received.
For example, when a company completes a construction project but the customer has not yet paid, this should be included in accrued income until payment is received.
Definition and examples of deferred revenue
Relative to accrued income, deferred income refers to the situation where the company does not complete the delivery of goods or services before receiving cash. According to the revenue recognition principle, the advance payment received is regarded as a liability because the enterprise is obliged to provide corresponding goods or services in the future.
For example, if a company accepts an advance payment from a customer to provide future services, this amount is recorded as deferred revenue until the services are actually completed.
Accounting treatment of accrual and deferral
In accounting terms, accrued revenue is considered an asset because it represents future cash inflows. Deferred revenue, on the other hand, is recorded as a liability because it is a future obligation of the business. Once services are actually performed or goods are delivered, deferred revenue can be converted into revenue while reducing liability.
International Financial Reporting Standards (IFRS) standards
International Financial Reporting Standards (IFRS) provide five key criteria for recognizing revenue, including the transfer of risks and rewards, the seller’s control over the goods sold, the collectability of payment, and the measurability of the amount of revenue. and the measurability of the costs required to generate revenue.
These standards are designed to ensure that revenue recognition is consistent and transparent during the business process, so that investors and stakeholders can clearly understand the financial status of the company.
New revenue recognition standards of ASC 606 and IFRS 15
In 2014, the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) released ASC 606 (or IFRS 15). This standard aims to improve the consistency of revenue recognition and introduce a five-step model. To recognize revenue, including contract identification, identification of performance obligations, determination of transaction price, allocation of transaction price and recognition of revenue.
Exceptions and long-term contracts
Although revenue is generally recognized at the time of sale, in certain exceptions the timing of revenue recognition may vary. For example, in long-term contracts, revenue can be recognized on a progress basis, especially in construction and large-scale development projects, which can help to more accurately reflect the financial position of the business.
For long-term contracts, companies can recognize revenue based on the percentage of completion, which can provide a more realistic revenue performance as the project progresses.
Authenticity and transparency of financial statements
The correct management and recognition of accrued revenue and deferred revenue is critical to a company's financial statements. They not only affect the company's balance sheet, but also directly affect the company's comprehensive income and its market image. A clear revenue recognition policy can enhance investor trust and promote more stable capital flows.
In a fast-paced business environment, how a company chooses and applies the correct revenue recognition method will directly affect its financial health and future business growth. Are you ready to understand the principles behind these financials?
