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 reliability and when the amount is recoverable.
Accrual basis of accounting is used in recognizing revenue which tells that revenue is to be recognized ignoring when the cash inflows occur.
- A telecommunication company sells talk time through scratch cards. No revenue is recognized when the scratch card is sold, but it is recognized when the subscriber makes a call and consumes the talk time.
- A monthly magazine receives 1,000 subscriptions of $240 to be paid at the beginning of the year. Each month it recognizes revenue worth $20,000 [($240 ÷ 12) × 1,000].
- A media company recognizes revenue when the ads are aired even if the payment is not received or where payment is received in advance.
In case where payment is received before the event triggering recognition of revenue happens, the debit goes to cash and credit to unearned revenue. In case the event triggering revenue recognition occurs before payment is received, the debit goes to accounts receivable and credit to revenue.
Revenue is the item which is the easiest to misstate, hence more stringent rules and guidance is required in this area. IAS 18 Revenue deals with recognition of revenue.