revenue recognition principle

Examples of revenue recognition principle in the following topics:

• Current Guidelines for Revenue Recognition

  • Transactions that result in the recognition of revenue include sales assets, services rendered, and revenue from the use of company assets.
  • The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle.
  • The principle allows a better evaluation of the income statement, which shows the revenues and expenses for an accounting period or how much was spent to earn the period's revenue.
  • Guidelines for revenue recognition will affect how and when revenue is reported on the income statement.
  • Explain how the revenue recognition principle affects how a transaction is recorded

• Importance of Recognition and Measurement

  • In accounting, recognition of revenues and expenses is based on the matching principle.
  • The revenue recognition principle and the matching principle are two cornerstones of accrual accounting.
  • According to the revenue recognition principle, revenues are recognized when they are realized or realizable and earned—usually when goods are transferred or services rendered—regardless of when cash is received.
  • In contrast to recognition is disclosure.
  • The matching principle is a culmination of accrual accounting and the revenue recognition principle.

• Revenue

  • Revenue refers to the mechanism by which income enters a company.
  • Revenue accounts indicate revenue generated by the normal operations of a business.
  • Revenue accounts have a normal credit balance.
  • Expenses should be matched with revenue.
  • Accounting principles provide guidance and rules on when to recognize revenue and expenses.

• Recognition of Revenue Prior to Delivery

  • Accrual accounting allows some revenue recognition methods that recognize revenue prior to delivery or sale of goods.
  • The accounting principle regarding revenue recognition states that revenues are recognized when they are earned (transfer of value between buyer and seller has occurred) and realized or realizable (collection is reasonably assured).
  • Revenue must be realizable.
  • Completion of production method: This method allows recognizing revenues even if no sale was made.
  • Distinguish between the percentage of completion method and the completion of production method of revenue recognition

• Other Current Liabilities: Sales Tax, Income Tax, Payroll, and Customer Advances

  • Net earnings are generally considered gross revenue minus expenses.
  • Accounting principles and tax rules about recognition of expenses and revenue will vary at times, giving rise to book-tax differences.
  • Deferred revenue is, in accrual accounting, money received for goods or services that have not yet been delivered and revenue on the sale has not been earned.
  • According to the revenue recognition principle, the deferred amount is recorded as a liability until delivery is made, at which time it is converted into revenue.
  • As the maintenance service is rendered and a portion of the fee is earned, $1,000 is recognized periodically each month as revenue and the deferred revenue account is reduced.

• Introduction to GAAP

  • Revenue and expense should be kept separate from personal expenses.
  • Revenue Recognition Principle: requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received.
  • Matching Principle: Expenses have to be matched with revenues as long as it is reasonable to do so.
  • Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue.
  • Consistency principle: the company uses the same accounting principles and methods from year to year.

• The Importance of Timing: Revenue and Expense Recognition

  • Revenue is recognized when earned and payment is assured; expenses are recognized when incurred and the revenue associated with the expense is recognized.
  • According to the principle of revenue recognition, revenues are recognized in the period when it is earned (buyer and seller have entered into an agreement to transfer assets) and realized or realizable (cash payment has been received or collection of payment is reasonably assured).
  • The matching principle, part of the accrual accounting method, requires that expenses be recognized when obligations are (1) incurred (usually when goods are transferred, such as when they are sold or services rendered) and (2) the revenues that were generated from those expenses (based on cause and effect) are recognized.
  • Without the matching principle and the recognition rules, a business would be forced to record revenues and expenses when it received or paid cash.
  • Explain how the timing of expense and revenue recognition affects the financial statements

• Current Guidelines for Expense Recognition

  • For an expense to be recognized under the matching principle, it must be both incurred and offset against recognized revenues.
  • Since most businesses operate using accrual basis accounting, expense recognition is guided by the matching principle.
  • Under the matching principle, the expense related to the raw material is not incurred until delivery.
  • The matching principle assumes that every expense is directly tied to a revenue generating event, such as a production of a good or service.
  • Explain how accrual accounting uses the matching principle for expense recognition

• Recognition of Revenue at Point of Sale or Delivery

  • Companies can recognize revenue at point of sale if it is also the date of delivery or if the buyer takes immediate ownership of the goods.
  • Since most sales are made using credit rather than cash, the revenue on the sale is still recognized if collection of payment is reasonably assured.
  • The revenue earned will be reported as part of sales revenue in the income statement for the current accounting period .
  • When the transfer of ownership of goods sold is not immediate and delivery of the goods is required, the shipping terms of the sale dictate when revenue is recognized.
  • A street market seller recognizes revenue when he relinquishes his merchandise to a buyer and receives payment for the item sold.

• Recognition of Revenue After Delivery

  • When a sale of goods transaction carries a high degree of uncertainty regarding collectibility, a company must defer the recognition of revenue.
  • In this situation, revenue is not recognized at point of sale or delivery.
  • There are three methods that recognize revenue after delivery has taken place: .
  • The seller records the cash deposit as a deferred revenue, which is reported as a liability on the balance sheet until the revenue is earned.
  • As the delivery of the magazines take place, a portion of revenue is recognized, and the deferred liability account is reduced for the amount of the revenue.