Service Revenues

Service revenues are the income a business earns from performing work for customers rather than from selling physical products. Accountants, lawyers, consultants, plumbers, airlines, hospitals, advertising agencies, cloud software providers and many others earn mainly service revenues. The account may also be called fees earned, professional fees or, for a specific business, names such as consulting revenue or commission income. It is related to fees earned, a term common in textbook examples for professional practices.

Service revenues are reported at the top of the income statement. A company that both sells goods and provides services, such as a manufacturer that also offers maintenance contracts, usually reports product revenue and service revenue on separate lines or in a note, because the two have different margins and growth patterns. Service revenue is a temporary account with a normal credit balance, closed to retained earnings at the end of each year.

Under the accrual basis of accounting and the rules in ASC 606 and IFRS 15, service revenue is recognized when the business satisfies its obligation to the customer, not when it is paid. Services fall into two broad patterns:

• Services performed at a point in time, such as a haircut or a one-off repair, are recognized when the service is complete.
• Services performed over time, such as a 12-month cleaning contract, a software subscription or a construction management engagement, are recognized progressively as the customer receives the benefit, using a measure of progress such as time elapsed, hours worked or milestones reached.

Cash received before the work is done is recorded as deferred revenue, a liability. Work completed but not yet billed at the period end is recorded as accrued revenue, an asset.

An IT consultancy completes a network installation for a client in March and sends an invoice for $15,000 on terms of net 30. It records a debit to accounts receivable of $15,000 and a credit to service revenue of $15,000. When the client pays in April, cash is debited and accounts receivable credited; no revenue is recorded in April.

The consultancy also signs a support contract on 1 March for $36,000 a year, paid in advance. It debits cash $36,000 and credits deferred revenue $36,000. At 31 March, one month of support has been delivered, so an adjusting entry moves $3,000 from deferred revenue to service revenue. Total service revenue for March is $15,000 plus $3,000, or $18,000. Separately, consultants worked 40 hours in the last week of March for another client at $150 an hour, to be billed in April. An adjusting entry records $6,000 of accrued revenue, raising March service revenue to $24,000.

Service businesses typically have little or no inventory and therefore little or no cost of goods sold. Their largest costs are usually staff salaries, which some present as cost of services, the direct cost of delivering the work, and the rest as operating expenses. Many small service businesses use a single-step presentation, simply listing revenues and then expenses. Key measures include revenue per employee, utilization, the share of hours billed to clients, and, for subscription businesses, monthly recurring revenue.

The main judgments in service revenue relate to timing. Multi-year contracts, bundled offerings that combine software, setup and support, and contracts with performance bonuses or penalties all require the contract price to be allocated and recognized in the right periods. Recognizing a full contract when it is signed, or billing ahead of work and treating the bills as revenue, overstates current results. Service companies that are paid by the hour must also make sure unbilled time is recorded only when it is collectible. Under the cash basis of accounting, used by many very small firms for tax purposes, service revenue is simply recorded when cash is received.