Accrued receivable definition
/What is an Accrued Receivable?
An accrued receivable is a trade receivable or a non trade receivable for which a business has earned revenue, but for which it has not yet issued an invoice to the customer.
When to Accrue a Receivable
An accrued receivable is normally created when a milestone has been reached in a contract with a customer, where the company is clearly entitled to a specific, predefined amount, but the contract terms do not yet allow it to issue an invoice. A receivable may also be accrued when the contract with the customer states that the customer will pay the company for hours worked, rather than for a specific work product. For example, there may be 10 hours of work that will eventually be billed at a rate of $80 per hour, so a receivable is accrued for $800.
Do not record accrued receivables if you cannot justify to an auditor that there is a clear obligation by the customer to pay the company for the amount of the accrued receivable. Otherwise, there is a presumption that the business has not yet reached the point where the customer has a clear obligation to pay. If you use accrued receivables, expect auditors to pay particular attention to their justification. For example, do not accrue receivables in a case where a business is providing services under a fixed fee contract, and it earns revenue only when the entire project is complete and approved by the customer. Revenue has not really been earned prior to completion, so there should be no accrual prior to that point.
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How to Create an Accrued Receivable
The journal entry to create an accrued receivable is a debit to an accounts receivable account, and a credit to the revenue account. It may be useful to create a unique general ledger account for accrued receivables, rather than using the main trade receivables account, in order to clearly show these transactions. In addition, set these journal entries to automatically reverse themselves in the next accounting period; you would then replace the accrual in the next period with the actual invoice (assuming that there is a billing event in the next period). If you are unable to create an invoice in the next period, then continue to accrue and reverse the revenue and accrued receivable in every period on a cumulative basis until you can eventually issue an invoice.
Example of an Accrued Receivable
For example, ABC International has completed a milestone in a project to install a dam, though it is not allowed under the contract to issue an invoice more frequently than once a quarter. It therefore accrues revenue and a receivable of $50,000 at the end of January. The journal entry automatically reverses at the beginning of February. ABC then earns another $30,000 on the next project milestone in February, but is still contractually unable to issue an invoice. It therefore accrues revenue and a receivable of $80,000 in February. The journal entry automatically reverses at the beginning of March. ABC then earns another $70,000 on the next project milestone in March. It is allowed to issue a quarterly invoice at the end of March, so it issues an invoice for $150,000. By using accruals, ABC has recognized $50,000 of revenue and receivables in January, $30,000 in February, and $70,000 in March, rather than recognizing all $150,000 in March, when it issues an invoice to the customer.