Revenue Recognition

Examples of Revenue Recognition 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.
  • Revenue is recognized due to the passage of time or as assets are used.
  • 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

• 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

• 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 assets produced and sold or services rendered to generate revenue also generate related expenses.
  • 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

• 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.

• 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.

• Defining Accounts Receivable

  • A company has a choice of when to actually recognize revenue via various accounting methods.
  • Revenue has a big impact on bottom-line profitability, so managers may be tempted to "manage" revenue recognition.
  • Under accrual accounting, a firm can recognize revenue when it has:
  • Managers can sometimes tweak the period in which revenue is recognized to create a more attractive financial statement for a given circumstance .
  • This chart lays out methods for accruing revenue and expenses in accounting.

• 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.
  • The same idea holds for revenue and incoming cash flows.

• 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.

• 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.
  • For an expense to be recognized, the obligation must be both incurred and offset against recognized revenues.
  • If a cost is not directly tied to any revenue generating activity, it is recognized as soon as it is incurred.
  • Explain how accrual accounting uses the matching principle for expense recognition

• Expense Recognition

  • Expense recognition is an essential element in accounting because it helps define how profitable a business is in an accounting period.
  • This makes the timing of expenses and revenues very important.
  • This means it is unimportant with regard to recognition when a business pays cash to settle an expense.
  • Calculate the ending balance of an income statement account and discuss how the proper recognition of expenses affects a company's income