Revenue recognition

Definition

Revenue recognition is the accounting principle dictating how and when revenue is recognized in financial statements. It ensures that revenue is recorded when it is earned, regardless of when the cash is received.

5 Must Know Facts For Your Next Test

1. Revenue must be realized or realizable and earned before it can be recognized.
2. The accrual accounting method requires revenues to be recognized when the sale occurs, not necessarily when cash is received.
3. The revenue recognition principle helps provide a more accurate picture of a company's financial health and performance.
4. There are five steps in the revenue recognition process: Identify the contract, identify performance obligations, determine transaction price, allocate transaction price to performance obligations, and recognize revenue when (or as) the entity satisfies a performance obligation.
5. Revenue recognition can impact financial metrics such as net income, which investors and analysts use to evaluate company performance.

Review Questions

• What are the criteria for recognizing revenue according to accrual accounting?
• Describe the five-step process for recognizing revenue.
• How does revenue recognition affect a company's financial statements?

Related terms

Accrual Accounting: A method where revenues and expenses are recorded when they are earned or incurred, not necessarily when cash changes hands.

Deferred Revenue: Money received by a company for goods or services yet to be delivered or performed.

Matching Principle: An accounting principle that dictates expenses should be reported in the same period as the revenues they help generate.