Businesses seem to be a little confused about ‘what is revenue recognition’ and its related attributes. To help such companies and entrepreneurs, allow us to address the definition, the importance of revenue recognition, examples, and other essential information about the subject matter.
Revenue is one of the best and most influencing factors in any business. The revenue of a business plays a major role in its growth and development. Not only that, but the revenue also ensures that all potential investors are attracted to your business instantly. However, it takes work to generate or even predict the revenue in any business.
Revenue recognition helps you with the same.
What is Revenue Recognition?
Revenue recognition, just like its name, is a technique that defines how \the revenue of any business will be recognized. In simpler terms, the concept deals with the subject matter of how or when the revenue of any business will be accounted for. The concept of revenue recognition is an integral and compliant part of the generally accepted accounting principles (GAAP).
The conditions and techniques of revenue recognition can be different for different kinds of businesses.
For some businesses where the goods or services are sold instantly and then payment is upfront, revenue recognition becomes very easy. Here, the revenue point becomes the date when the payment is received by the businessman, cash or otherwise. This feature is quite common in the retailing outlets.
A common misconception related to the concept is that revenue recognition is the point when the cash is received by the business. However, the reality is quite different. When a business is employed with some kind of service or offers a product that may not get an upfront payment, then the time of recognition becomes different. This difference makes the concept complicated and sensitive.
With the help of this article, we will have a look at some factors and other information related to the recognition of revenue. From the importance of revenue recognition to revenue recognition examples and much more, you will find everything in the later sections. This information will prove to be quite crucial for businesses that have an indefinite period of recognition. So, let’s start with some basic terminologies commonly used under the subject matter.
Revenue Recognition Terminologies
You are already familiar with “what is revenue recognition”, now let’s talk about the terminologies involved. Whenever the concept of recognizing the revenue surfaces, you will come across some unique terms related to the subject matter. For your benefit and ease, you should make yourself familiar with such terminologies right away.
Earned or Recognized Revenue
The term that you will come across the most is Earned or Recognized Revenue. This term is used for the revenue that generates when the product or service is delivered to the customer and payment for the same is received.
One of the most common revenue recognition examples is the money received by the cashier at any store after the sale.
The next is the accrued income. This is the form of revenue in which the service or goods provider has already delivered the same but the payment for such a product or service has not been received. This type of transaction is considered an asset as the money is yet to be received.
One of the most common accrued revenue recognition examples is real estate establishments. As the time period involved in such projects is quite big, the seller or provider may receive the complete payment for the same after a specific date rather than instant.
At last, there is Deferred Revenue. This is the form of revenue where the business receives advance money but the product or service is yet to be delivered to the buyer. This type of transaction is considered a liability as the money/order is yet to be delivered.
One of the most suitable deferred revenue recognition examples is the membership purchased in advance for any club.
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Revenue Recognition: Important for Which Business(s)
Yes, recognition of the total revenue is beneficial for a business. But one may ask, which business does it affect or benefit the most? The simple answer to this is the business involved in long-period projects but receiving advance payment for the services or goods to be delivered. As the tenure of such businesses is affected every year as the project proceeds, it becomes quite important to recognize the revenue. Such companies include Software as a Service companies, real estate developers, professionals, etc.
Let’s understand how the concept of recognition works with the help of revenue recognition examples.
Revenue Recognition Examples: Products and Services
Below are some revenue recognition examples that will allow you to get a gist of the working of the concept right away:
A Product Selling Business
In-store retailer: the revenue is recognized when your customer walks into the store, makes the purchase, and pays for the same.
A Contractor: a customer connects with you and places an order to manufacture 12 slabs of marble. He offers to complete the entire payment of $3,600 for this at the time of the delivery. You can not enter this amount at once in your sheets as it will affect and unbalance the accounts. So, you will complete the delivery of specific slabs over time and enter the payment for the same in the respective month. The rest of the amount that you are yet to receive, is the accrued income for your business.
A Service Based Company
Here is another one of the revenue recognition examples. Consider that a golf club is offering the players to join it at the price of $12,000 per annum. One player pays the entire amount at the beginning of the year. Now, the complete amount of $12,000 would not be the revenue of the club for that month. Rather, it will consider a total of $1,000 each month as the actual revenue while the remaining would be the deferred revenue.
Importance of Revenue Recognition
One may wonder whether accurate and timely revenue recognition is important for his/her business or not. The answer to this is yes. It is very important for all kinds of businesses to recognize whether revenue is earned, accrued, or deferred for accurate accounting and various other benefits.
When the concept of revenue recognition is not followed perfectly by a business. The actual status of the operations would not be reflected by the books of accounts. To understand, let’s understand this with the help of one of the revenue recognition examples provided above.
Consider that a golf club is offering the players to join it at the price of $12,000 per annum. As the player is making the complete payment upfront for the membership of a year. Your total revenue for the month of joining would be $12,000 but that for the rest of the tenure will be $0. This may reflect a bad image of your business. That you only get the member for one month and then our business went down. Whereas if you show a regular revenue of $1,000. It will create an image that you are getting a steady revenue in all months and seasons.
When it comes to investors, they only appreciate one thing, clarity. If you are following the principles of accounting and proceed with revenue recognition accordingly. You can create a sense of steadiness and honesty.
Once you prove the reliability of the data, you can increase your chances of getting better and bigger investments.
Things to Ensure For Accurate Revenue Recognition
Although you have got the details related to “what is revenue recognition” and its related attributes. The concept is still very complicated to execute. This is one of the main reasons why businesses tend to seek the assistance of smart CFO services, like those offered by Ledger Labs. Such professionals have the required knowledge about the principles for recording the revenue and the policies set up by the IRS.
However, there are other factors as well that you can follow to ensure that you always recognize the correct amount of revenue:
- Make sure that whenever you are dealing with any customer. You lay out the time of delivery of the order as well as the payment.
- Even out individual goods or services as purchased or hired, altogether, in a single order.
- Lay out the price or cost of the product or service, individually as well as all together.
Now that you have followed the above virtues, you can now proceed to recognize the revenue.
Revenue Recognition: A Guarantor of Success
So, we can safely end this entire write-up on what is revenue recognition. We hope that now you have more than enough information to follow the process of recognizing the revenue. It’s better for every type of business to show an accurate image and financial position in the market, to investors, customers, the IRS, and others. This will help you run your business peacefully and reach your goals perfectly.
Hi, I am Gary Jain & I help business owners in taking control of their business finances by being a one-stop solution for all their accounting, taxation & CFO advisory needs.
Being an entrepreneur myself, having built and scaled businesses in a variety of domains, has helped me think from the perspective of the business owners and thus bringing in the clarity of the practical problems and their equally practical solutions.
Being from a humble background, I have always valued the importance of conserving resources & I dont like overspending businesses. I advise and work towards tightening the cash outflow tap and making business owners take a very different approach to managing their finances.