Revenue Recognition

First, lets define What is Revenue?

Revenue is the income generated from normal business operations. It is the top line or
gross income figure from which costs are subtracted to determine net income. It is the
money brought into a company by its business activities. And it is considered as the heart
of all business performance.

Next, What is Revenue Recognition?

Revenue recognition is an accounting principle that outlines the specific conditions under
which revenue is recognized.

Conditions for Revenue Recognition

For a revenue to be recognized, the following conditions must be satisfied:
1.Risks and rewards of ownership have been transferred from the seller to the buyer.
2.The seller does not have control any longer over the goods sold.
3.The collection of payment from goods or services is reasonably assured.
4.The amount of revenue can be reasonably measured.
5.Costs of revenue can be reasonably measured.

Conditions (1) and (2) are referred to as Performance. Regarding performance, it occurs
when the seller has done what is to be expected to be entitled to payment.
Condition (3) is referred to as Collectability. The seller must have a reasonable
expectation that he or she will be paid for the performance.
Conditions (4) and (5) are referred to as Measurability. the seller must be able to match
the revenues to the expenses. Hence, both revenues and expenses should be able to be
reasonably measured.

Steps in Revenue Recognition from Contracts

The five steps for revenue recognition in contracts are as follows:
1. Identifying the Contract
•Both parties must have approved the contract (whether it be written, verbal, or implied).
•The point of transfer of goods and services can be identified.
•Payment terms are identified.
•Collection of payment is probable.

2. Identifying the Performance Obligations

Performance obligations must be distinct from each other. The following conditions must
be satisfied for a good or service to be distinct:
•The buyer (customer) can benefit from the goods or services on its own.
•The good or service is separately identified in the contract.

3. Determining the Transaction Price

The transaction price is usually readily determined; most contracts involve a fixed amount.
4. Allocating the Transaction Price to Performance Obligations
The allocation of the transaction price to more than one performance obligation should be
based on the standalone selling prices of the performance obligations.

5. Recognizing Revenue in Accordance with Performance

Recall the conditions for revenue recognition. Conditions (1) and (2) state that revenue
would be recognized when the seller has done what is expected to be entitled to payment.
Therefore, revenue is recognized either:
•At a point in time; or
•Over time

accrual accounting/accruals. It is the accounting principle that recognizes revenue when

earned and associated expenses when incurred, not when money is received/paid.

cash accounting. It is the accounting principle that recognizes revenue when cash is
received and recognizes expense when cash is paid.
2 Methods of Revenue Recognition
1. Completed Contract Method- under this method, all revenues, costs, and
income are recognized only at completion of the construction project, ordinarily
at the end of the construction contract.
2. Next is what our company has been currently using-the % of Completion
Method – wherein recognizes revenue over the life of the construction contract
based on the degree of completion. revenue is recognized proportionately to
"the extent of work accomplished" by the contractor and is usually documented
or attested to by an engineer
% complete = Total costs incurred to date/ Estimated total cost

The percentage of completion is then derived from a simple formula, "actual

costs incurred to date" divided by "estimated total costs to complete the
contract". In this formula, the total cost to complete a project is equal to actual
costs incurred to date for a project plus the estimated costs to complete the
project.