Revenue Recognition:
Revenue Recognition principle is one of the important principles of Accrual Accounting. According to this principle, revenue must be recognized when (1) They are realized or realizable and (2) They are earned Revenue is realized when products are exchanged for cash or claims to cash (Receivable). Revenue is realizable when related assets received are readily convertible to cash or claims to cash. Revenue is earned when the products are delivered or services are performed. Recognizing the revenue means recording the amount as revenue in the financial statements. Realization is the process of converting non-cash resources into cash. In the Revenue Recognition principle, it does not matter when cash is received. (In Cash Basis Accounting, revenue is recognized when cash is received no matter when goods or services are sold). For revenue to be recognized, both the above conditions must be met. In other words for revenue to be recognized, final delivery must be completed (of goods or services) and there has to be a payment assurance. Let us have a look at the timing of Revenue Recognition 1) For sale of finished goods (Inventory Items), revenue is recognized at the date of sale (some interpret this as the date of shipping or the date of delivery) 2) For sale of services (e.g. support services), revenue is recognized when the services are performed (delivered) 3) For sale of Asset Items (other than inventory items like finished goods), revenue is recognized at the point of sale (i.e. when the customer is invoiced) 4) For revenue from other activities like rent for using company¶s Fixed Assets, revenue is recognized as time passes or as assets are used.

1) If a company invoices its customer for 100 units of item µA¶, and ships (delivers) only 25 units, the company cannot recognize revenue for entire 100 items. It can only recognize revenue equivalent to the number of units delivered (Revenue is earned only when the products are

Since. The fact that company µABC¶ received money for one full year does not mean that they can record the entire amount as Revenue. In this scenario. Assuming the company is following a monthly calendar accounting period. Deferred Revenue is actually a liability for the company. But then if you are not crediting the revenue right away. In-fact the amount received in advance is a Liability to the company because they have to deliver magazines to their customer every month and if they fail to do so. How this receivable is collected will depend on the payment terms of the Invoice 1-Jan Deferred Revenue 12000 . Accounting when the Invoice is created in Jan Date 1-Jan Accounting Class Debit Receivables 12000 Credit Comments The entire receivables is recognized in advance. the Deferred Revenue is reduced (debited) and revenue is recognized. the revenue should be recognized only after the expiration of the return policy period. This amount cannot be recorded as revenue unless the Company provides the support services to the client. Under normal scenario. (The company is liable to provide the goods or services for which cash is received or will be received in advance). where do you account for the credit side of the accounting entry? You credit. you debit your Receivables. (Revenue is recognized when services are performed) There are few exceptions to the timing of revenue recognition for sale of inventory items. the company will recognize 1/36th of the entire support contract deal amount every month. you are invoicing the customer in Advance. and if the company cannot reasonably estimate the amount of future returns.delivered). As and when the goods or services are delivered. what is called as Deferred Revenue (or Unearned Revenue). 2) Company µZXC¶ signs a 3 year support contract with its client for a total amount of 3 million. what is the accounting entry for the Sales Invoice? Let¶s have a look Let¶s say. the company will recognize 1/12th of the entire amount every month as earned revenue after they deliver the magazine. revenue is recognizes at the point of sale. however if there are return policies. Revenue Recognition Accounting: If revenue is not recognized immediately. you invoice the Customer in Advance for the annual support contract of $12000. let¶s say you pay $120 in advance to company µABC¶ for magazine subscription for one full year. Similarly. they are liable to refund the amount received in advance.

http://oracle. the Deferred Revenue will be Zero and the entire amount will be reported as Revenue earned. Revenue is recognized for 1/12th of the entire amount. At the end of . To that effect. another months revenue is recognized Date 28-Feb 28-Feb Accounting Class Deferred Revenue Earned Revenue Debit 1000 1000 Credit Comments Deferred Revenue reduced Earned Revenue amount for one month The company will have similar accounting entry each month till Dec. Deferred Revenue will be reduced and revenue will be recognized Date 31-Jan 31-Jan Accounting Class Deferred Revenue Earned Revenue Debit 1000 1000 Credit Comments Deferred Revenue reduced Earned Revenue amount for one month End of Feb.anilrpatil. because the company has provided one month¶s service to its client.End of Jan.