Revenue Recognition

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Definition: Revenue Recognition

Revenue recognition principle is the basis of an accrual accounting & the matching principle. Both of them determine the accounting period in which the revenues & the expenses are recognized. By this principle, revenues are recognized if they are realized or are realizable & are earned, generally after the goods are transferred & the services are rendered, independent of when the cash is received. While in cash accounting, revenues are recognized when the cash is received independent of when the goods or the services are sold.

Cash may be received in earlier or a later period than the obligations are met i.e. when the goods & the services are delivered & the revenues are recognized which results in the 2 types of accounts:

• Accrued revenue: The revenue is recognized before the cash is received.

• Deferred revenue: The revenue is recognized after the cash is received.

International Financial Reporting Standards uses the critical event approach to recognize the revenue. It provides 5 different criteria to identify the critical event to recognize the revenue on the sale of the goods.

1. Transfer of the risk & the reward to the buyer from the seller

2. No control of the seller on the goods sold

3. payment collection is reasonably assured

4. The revenue amount can be measured reasonably

5. & the cost of earning it can also be reasonably measured

Top 2 are referred as Performance which means seller’s job is over & now, he is eligible to get the payment.

E.g.: A company had sold the goods & the customer has walked out of the store & the product had no warranty. Here, the seller has completed its performance because now, the buyer owns the good as well as all the risk & the reward associated with the product.

Third one is referred as the Collectability. A seller should have a reasonable expectation of being paid. So, an allowance account should be made if seller is not assured of receiving the payment. Last 2 are referred as Measurability. Due to the Matching Principle, a seller should be able to match the expenses to the revenues they helped in earning it. So both the revenues as well as the expenses should be reasonably measurable.

Revenue recognition from the 4 types of transactions:

1. Revenues from the sale of an inventory are recognized on the date of sale generally taken as the date of delivery.

2. Revenues from the services are recognized after the services are completed & billed.

3. Revenues from permission to use the assets of a company are recognized as assets are used.

4. Revenues from the selling of some assets other than inventory are recognized when the sale actually takes place.

These are the general rules but there are some exceptions in some cases like buyback agreement or return policy etc.



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