Unbilled revenue

What Is Unbilled Revenue?

Unbilled revenue represents income that a company has earned by delivering goods or services but has not yet formally invoiced to the customer. This concept is fundamental to accrual basis accounting, a core principle of modern financial reporting and a key area within the broader field of accounting. Unlike accounts receivable, which refers to amounts already invoiced and awaiting payment, unbilled revenue precedes the invoice stage. It signifies that the company has completed its performance obligations or a portion thereof, entitling it to payment, even if the formal billing process has not been completed. Therefore, unbilled revenue is recognized as an asset on a company's balance sheet, reflecting the future economic benefit derived from work already performed.

History and Origin

The concept of recognizing revenue when it is earned, rather than when cash is received, is a cornerstone of accrual basis accounting, which gained prominence to provide a more accurate picture of a company's financial performance. This method aligns with the matching principle, which dictates that expenses should be recognized in the same period as the revenues they helped generate. The Internal Revenue Service (IRS) outlines the accrual method, noting that income is generally reported in the tax year it is earned, irrespective of when payment is received.⁶ This principle is critical for situations where the delivery of goods or services and the subsequent billing cycle do not coincide. Over time, as business transactions became more complex, particularly with long-term projects and service contracts, the need for consistent revenue recognition standards became apparent. This led to the development and widespread adoption of frameworks such as Generally Accepted Accounting Principles (GAAP) in the U.S. and International Financial Reporting Standards (IFRS) globally. The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers" (Topic 606), in May 2014, which established a comprehensive framework for revenue recognition, emphasizing the transfer of control of goods or services to the customer.⁵ This standard further solidified the importance of recognizing revenue as it is earned, even if unbilled, to accurately reflect a company's performance.

Key Takeaways

• Unbilled revenue refers to income earned by providing goods or services for which an invoice has not yet been issued.
• It is an asset on the balance sheet, reflecting a company's right to receive payment for work already performed.
• The recognition of unbilled revenue is a direct application of accrual basis accounting and the revenue recognition principle.
• Commonly arises in businesses with long-term contracts, milestone-based billing, or service agreements where billing occurs periodically.
• Proper accounting for unbilled revenue ensures that financial statements accurately reflect a company's economic activity during a reporting period.

Interpreting Unbilled Revenue

Interpreting unbilled revenue involves understanding its implications for a company's financial health and operational efficiency. A high amount of unbilled revenue could indicate that a company is performing a significant volume of work that is yet to be converted into accounts receivable and, subsequently, cash. While it signifies earned income, it also means that the cash flow from that revenue is delayed until the billing and collection process is complete.

Analysts often examine trends in unbilled revenue to assess a company's operational tempo and billing efficiency. For instance, a growing balance of unbilled revenue might suggest strong ongoing project work, but if it grows disproportionately to total revenue, it could point to delays in the invoice cycle or contractual billing complexities. It is crucial to evaluate unbilled revenue in conjunction with a company's overall financial statements, including the income statement and cash flow statement.

Hypothetical Example

Consider "Tech Solutions Inc.," a software development company that undertakes a large custom software project for a client, "ClientCo." The contract stipulates that Tech Solutions Inc. will bill ClientCo monthly based on the percentage of project completion, but only after specific milestones are achieved.

In July, Tech Solutions Inc. completes 25% of the project, which, according to the contract, represents earned revenue of \$100,000. However, the next billing milestone is not until the end of August. As of July 31st, Tech Solutions Inc. has earned the \$100,000, but it cannot issue an invoice yet.

On its July 31st balance sheet, Tech Solutions Inc. would record this \$100,000 as unbilled revenue. The corresponding journal entry would typically involve debiting an "Unbilled Revenue" or "Accrued Revenue" asset account and crediting the "Service Revenue" account on the income statement. When the billing milestone is met in August and the invoice is sent, the unbilled revenue would then be reclassified to accounts receivable.

Practical Applications

Unbilled revenue is particularly prevalent and important in industries characterized by long-term contracts, service agreements, or project-based work where the completion of services and the issuance of an invoice are separated in time.

• Construction and Engineering: Companies often work on large projects that span months or years. Revenue is earned as work progresses, but billing may occur only upon reaching certain construction milestones or at fixed intervals. For government contractors, specific revenue recognition guidelines, often influenced by ASC 606, dictate how and when this revenue is recognized, even if not yet billed.⁴
• Consulting and Professional Services: Law firms, consulting agencies, and IT service providers frequently accrue unbilled revenue for hours worked or services rendered before the client is formally billed, which might happen weekly, bi-weekly, or monthly.
• Software and SaaS (Software as a Service): For custom software development or large enterprise software implementations, revenue may be recognized based on project completion or delivery of specific modules, even if the final billing schedule stretches over a longer period.
• Government Contracting: Federal government contracts often involve complex billing schedules, with revenue being earned based on cost incurrence or percentage of completion, leading to significant amounts of unbilled revenue at any given time.³ The Department of Defense (DoD) for example uses accrual accounting, where revenues are recognized when earned and costs when incurred, irrespective of payment timing.²

Accurate tracking of unbilled revenue is critical for financial reporting, ensuring that a company's reported revenue reflects actual economic activity rather than just invoicing cycles. It impacts the calculation of key financial metrics, including working capital and profitability.

Limitations and Criticisms

While essential for accurate accrual accounting, unbilled revenue can present certain limitations and areas for scrutiny:

• Subjectivity in Estimation: Recognizing unbilled revenue often requires significant management judgment, especially for long-term projects or complex service agreements. Estimating the percentage of completion or the value of services rendered can introduce subjectivity, which might be open to manipulation or error. This subjectivity is a common challenge in applying revenue recognition standards like ASC 606, which require judgments and estimates.¹
• Cash Flow Disconnect: A growing unbilled revenue balance does not necessarily translate to immediate positive cash flow. This can create a disconnect between reported profitability and actual liquidity, potentially impacting a company's ability to cover its expenses or invest in future growth.
• Risk of Non-Collection: While unbilled revenue represents earned income, it is not yet an accounts receivable and carries the inherent risk that the client might dispute the amount or fail to pay once invoiced. Although it is recognized as an asset, its ultimate realization into cash depends on successful billing and collection.
• Auditing Complexity: The subjective nature and potential for delayed billing can make auditing unbilled revenue balances more complex, requiring auditors to carefully examine underlying contracts, project progress reports, and internal controls to verify the accuracy of the recognized amounts. This often necessitates robust internal controls and detailed documentation.

These factors underscore the importance of transparent disclosure and clear accounting policies regarding unbilled revenue to provide stakeholders with a true and fair view of a company's financial position.

Unbilled Revenue vs. Accrued Revenue

The terms "unbilled revenue" and "accrued revenue" are often used interchangeably, and in many contexts, they refer to the same underlying concept: revenue that has been earned but not yet received in cash. However, "accrued revenue" is the broader accounting term used to describe income earned but not yet billed or collected, generally referring to the asset account on the balance sheet where such earnings are recorded. "Unbilled revenue" specifically emphasizes the aspect that an invoice has not yet been issued. While all unbilled revenue is a type of accrued revenue, not all accrued revenue is necessarily "unbilled" in the sense of awaiting initial billing. For instance, interest earned on a bond but not yet received is accrued revenue, but it doesn't typically undergo a separate "billing" process. Therefore, "unbilled revenue" focuses on the stage in the revenue cycle before formal billing, while "accrued revenue" is the general classification for earned-but-not-received income under accrual basis accounting.

FAQs

Why is unbilled revenue recorded as an asset?

Unbilled revenue is recorded as an asset because it represents a future economic benefit to the company. The company has already performed the work or delivered the goods, establishing a right to receive payment, even if the formal billing process has not yet occurred. This aligns with the principles of accrual basis accounting, which recognizes revenue when earned.

How does unbilled revenue differ from accounts receivable?

The primary difference lies in the billing stage. Unbilled revenue refers to revenue that has been earned but for which an invoice has not yet been issued to the client. Accounts receivable, on the other hand, represents revenue for which an invoice has already been sent, and the company is awaiting payment. Unbilled revenue becomes accounts receivable once the invoice is generated.

What industries commonly have unbilled revenue?

Industries that typically experience unbilled revenue include those with long-term contracts, project-based work, or recurring service agreements where billing cycles do not perfectly align with the completion of work. This includes sectors like construction, engineering, consulting, professional services, software development, and government contracting.

Does unbilled revenue affect a company's cash flow?

Yes, unbilled revenue directly affects a company's cash flow by delaying it. While the revenue is recognized on the income statement, the cash associated with that revenue will not be received until the service is billed and the invoice is paid. A large or growing unbilled revenue balance can indicate strong sales but also a lag in converting those sales into cash.