Overview of the P&L Impact of Invoices in Accrual Accounting
Overview:
In Accrual Accounting, revenue is recognized when an invoice is issued, not when payment is received. This principle ensures that financial statements accurately reflect income earned within a specific period. However, complications arise when an invoice is later refunded or voided. This article outlines the impact of these transactions on the Profit & Loss (P&L) statement.
Quick Reference:
1. Invoice Creation
When an invoice is created, revenue is recorded immediately in the period it is issued, regardless of when or if payment is received.
P&L Impact:
Revenue Increases by the invoice amount.
No immediate impact on cash flow.
Example: An invoice for $5,000 is issued in January. The P&L for January reflects a $5,000 increase in revenue, even if payment has not yet been received.
2. Payment is Received
When the customer pays the invoice, the transaction affects the balance sheet but not the P&L, since revenue was already recorded when the invoice was issued.
P&L Impact:
No change.
The payment increases Cash and decreases Accounts Receivable on the Balance Sheet.
Example: The $5,000 invoice is paid in February. The revenue remains recorded in January’s P&L, while the February transaction only affects cash flow.
Balance Sheet Impact:
The payment increases cash and decreases Accounts Receivable on the Balance Sheet.
3. Refund of a Payment
When a payment is refunded, the method used to record the refund determines the impact on the P&L.
Using a Credit Memo
Revenue Decreases in the period the refund is issued.
The P&L accurately reflects the reversal of income.
Use the Bank Deposit Function
- Accounts Receivable as the account in the deposit and reduce the outstanding balance in A/R. This will decrease the customer’s balance and tie the refund to their profile.
Recording as an Expense
Instead of reducing revenue, the refund is categorized under an Expense Account (e.g., "Refunds & Allowances").
Total expenses increase, impacting net profit.
Example: The $5,000 payment is refunded in March:
If recorded as a credit memo: Revenue in March is reduced by $5,000.
If recorded as an expense: The March P&L shows a $5,000 increase in expenses instead of a reduction in revenue.
4. Voiding an Invoice After Payment and Refund
If an invoice is voided after payment has been received and refunded, its impact depends on the timing of each action:
Voiding in the Same Period as Creation
The invoice is removed before financials are finalized, and there is no net impact on the P&L.
Voiding After a Period Has Closed
The revenue remains recorded in the original period.
The refund offsets revenue (or increases expenses) in a later period.
Example:
A $5,000 invoice is issued in January (increasing January revenue).
Payment is received in February (no P&L impact).
The payment is refunded in March, reducing revenue or increasing expenses.
The invoice is voided in April, but January’s P&L remains unchanged.
