Revenue recognition

The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.
Cash can be received in an earlier or later period than obligations are met (when goods or services are delivered) and related revenues are recognized that results in the following two types of accounts:
Revenue realized during an accounting period is included in the income.
International Financial Reporting Standards criteria.
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IFRS provides five criteria for identifying the critical event for recognizing revenue on the sale of goods:
The first two criteria mentioned above are referred to as Performance. Performance occurs when the seller has done most or all of what it is supposed to do to be entitled for the payment. E.g.: A company has sold the good and the customer walks out of the store with no warranty on the product. The seller has completed its performance since the buyer now owns good and also all the risks and rewards associated with it.
The third criterion is referred to as Collectability. The seller must have a reasonable expectation of being paid. An allowance account must be created if the seller is not fully assured to receive the payment. The fourth and fifth criteria are referred to as Measurability. Due to Matching Principle, the seller must be able to match expenses to the revenues they helped in earning. Therefore, the amount of Revenues and Expenses should both be reasonably measurable
General rule.
Received advances are not recognized as revenues, but as liabilities (deferred income), until the conditions (1.) and (2.) are met.
Recognition of revenue from four types of transactions:
Revenue versus cash timing.
"Accrued revenue" (or "accrued assets") is an asset such as proceeds from delivery of goods or services. Income is earned at time of delivery, with the related revenue item recognized as "accrued revenue". Cash for them is to be received in a later accounting period, when the amount is deducted from "accrued revenues".
"Deferred revenue" (or "deferred income") is a liability, such as cash received "from a counterpart for goods or services" which are to be delivered in a later accounting period. When the delivery takes place, income is earned, the related revenue item is recognized, and the "deferred revenue" is reduced.
For example, a company receives an annual software license fee paid out by a customer upfront on January 1. However the company's fiscal year ends on May 31. So, the company using accrual accounting adds only five months worth (5/12) of the fee to its revenues in profit and loss for the fiscal year the fee was received. The rest is added to "deferred income" (liability) on the balance sheet for that year.
Advances.
Advances are not considered to be a sufficient evidence of sale; thus, no revenue is recorded until the sale is completed. Advances are considered a deferred income and are recorded as liabilities until the whole price is paid and the delivery made (i.e. matching obligations are incurred).
Exceptions.
Revenues not recognized at sale.
The rule says that revenue from selling inventory is recognized at the point of sale, but there are several exceptions.
Revenues recognized before sale.
Long-term contracts.
This exception primarily deals with long-term contracts such as constructions (buildings, stadiums, bridges, highways, etc.), development of aircraft, weapons, and spaceflight systems. Such contracts must allow the builder (seller) to bill the purchaser at various parts of the project (e.g. every 10 miles of road built).
Completion of production basis.
This method allows recognizing revenues even if no sale was made. This applies to agricultural products and minerals. There is a ready market for these products with reasonably assured prices, the units are interchangeable, and selling and distributing does not involve significant costs.
Revenues recognized after Sale.
Sometimes, the collection of receivables involves a high level of risk. If there is a high degree of uncertainty regarding collectibility then a company must defer the recognition of revenue. There are three methods which deal with this situation:
New Revenue Recognition Standard.
On May 28, 2014, the FASB and IASB issued converged guidance on recognizing revenue in contracts with customers. The new guidance is heralded by the Boards as a major achievement in efforts to improve financial reporting. The update was issued as Accounting Standards Update (ASU) 2014-09. It will be part of the Accounting Standards Codification (ASC) as Topic 606: "Revenue from Contracts with Customers" (ASC 606)"," and supersedes the existing revenue recognition literature in Topic 605 issued by FASB. ASC 606 is effective for public entities for the first interim period within annual reporting periods beginning after December 15, 2017; non-public companies were allowed an additional year.
The new standard aims to:
The new revenue guidance was issued by the IASB as IFRS 15. The IASB’s standard, as amended, is effective for the first interim period within annual reporting periods beginning on or after January 1, 2018, with early adoption permitted.