So when do you recognize revenue in your reports, statements and forecasts? Let's start with defining the revenue recognition principle, and then we'll pick it apart:
Revenue Recognition Principle:
"Revenue recognition principle tells that revenue is to be recognized only when the rewards and benefits associated with the items sold or service provided is transferred, where the amount can be estimated reliably and when the amount is recoverable." -Accounting Explained
The textbook definition of the revenue recognition principle is:
Revenue recognition generally occurs (1) when realized or realizable and (2) when earned.
When a company exchanges products, merchandise, or other assets for cash or claims to cash. For example:
1. A monthly online academic journal receives 2,000 subscriptions of $180 to be paid at the beginning of the year. Each month it recognizes revenue worth $30,000 [($180 ÷ 12) × 2,000].
A company can consider revenues as earned when they have markedly accomplished what they have to do to be entitled to the benefits of the revenues.
Sales provide a verifiable measure of revenue--the sales price. If you attempt to recognize revenue before an actual sale occurs, you open the door to wide interpretations. Sales provide an objective and uniform test for revenue recognition.
"Companies recognize expenses not when they pay wages or make a product, but when the work (service) or the product actually contributes to revenue. Thus, companies tie expense recognition to revenue recognition. That is, by matching efforts (expenses) with accomplishment (revenues), the expense recognition principle is implemented in accordance with the definition of expense (outflows or other using up of assets or incurring of liabilities)." - Intermediate Accounting, 13th Edition
"Often, a business will spend cash on
producing their goods before it is sold or will receive cash for good sit has
not yet delivered. Without the matching principle and the recognition rules, a
business would be forced to record revenues and expenses when it received or
paid cash. This could distort a business's income statement and make it look
like they were doing much better or much worse than is actually the case. By
tying revenues and expenses to the completion of sales and other money
generating tasks, the income statement will better reflect what happened in
terms of what revenue and expense generating activities during the accounting
period." -Boundless
You want your reports and statements to be as accurate and as transparent as possible. Making sure you've recognized revenue and expenses at the right times will help you grow your business as you look for investors and satisfy shareholders.