Reviewed by Aug 27, 2020| Updated on
Revenue recognition refers to one of the key accounting principles and part of the GAAP (Generally Accepted Accounting Principle). The principle specifies the conditions subject to which revenue should be recognised in the books of accounts of a company. Basically, the principle of revenue recognition states that revenue recognition occurs after the business event.
Understanding Revenue Recognition
- In most cases, accounting for revenues is clear cut and straight forward. A company needs to recognise revenues on the sale of a product or service. However, in different types of industries, revenue accounting is dependent on the nature of the industry and their revenue contracts. For example, in a real estate development industry, the revenue generation is staggered over the period of the project.
- The principle of revenue recognition follows the accrual method of accounting. That means all revenue that accrues gets recognised irrespective of the actual collection. Revenue recognition gets complicated in many situations because of contractual agreements and regulatory issues. In general, most revenue authorities desire recognition of revenue irrespective of the completion of a project.
- In each country, the revenue recognition standards lay down principles for different types of industries. For example, in India, the revenue recognition standard requires revenue recognition on percentage of completion method fo real estate sector. The standard recognises the difficulties faced by any industry and sets the guiding principles.
- A uniform accounting standard or principle across industry helps in making financial comparisons and studying the sectoral performance. The guiding factors include that revenue should be realisable but not necessarily received. In many cases, the statutory auditors facilitate recognition of unbilled revenue. There must be reasonable certainty that the company will receive the revenue.
The principle of revenue recognition requires that the activity of sale or service should be complete even if the payment for the goods or services happens later. Thus, the revenue should be earned for the purpose of recognition. And, there must be reasonable certainty about its receipt. It is important to correctly recognise the revenue for a period along with the costs associated with the revenue generation.