The Revenue Recognition Principle - dummies

The Revenue Recognition Principle

By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

The matching principle requires that you match costs incurred with the revenue a company generates. The revenue recognition principle requires that, if you use the accrual basis of accounting, you recognize revenue by using these two criteria:

  • Revenue is recorded when it has been earned

  • Revenue is considered earned when the revenue generation process is substantially complete

Generally, the revenue generation process is complete when you deliver your product or service. So, when the clothing store receives jeans from the manufacturer, the company that produced the jeans should recognize revenue. If you’re a tax accountant, you recognize revenue when you deliver the completed tax return to the client.

With accrual accounting, you can recognize revenue prior to receiving any payment from the client. A company recognizes revenue as soon as it delivers the goods or services.

For businesses that use accrual accounting, revenue recognized for the month may be very different from cash inflows for sales for the same period. Specifically, the increase in cash may not equal sales for the month.

A business using cash-basis accounting recognizes revenue when the cash is received from the client. If you review the checkbook of a cash-basis company, the deposits for the month will match the revenue for the month. Most businesses, however, use the accrual-basis of accounting.