Q:
What is an accrued receivable?
Answer
An accrued receivable is either 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. You normally create an accrued receivable in either of the following scenarios:
* Milestone. A milestone has been reached in a contract with a customer, where you are clearly entitled to a specific, pre-defined amount, but the contract does not yet allow you to issue an invoice; or
* Services. The contract with the customer states that the customer will pay you 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 you accrue the receivable for $800.
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, you should 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 you should continue to accrue and reverse the revenue and accrued receivable in every period on a cumulative basis until you can eventually issue an invoice.
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.
You should not use 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, you should 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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