Revenue (Sales) Recognition Process : Definition, Process, Journal Entries

What is Revenue Recognition?

Revenue recognition is the process of recording revenue of the business concern. It is recognized in the accounting period when it is earned, this not necessary whether cash have been received or not against delivery. Revenue earned means when the goods/supplies are delivered to the customers & Service are rendered. This is assumed by the most of the organizations that revenue has been earned at a consistent point in the accounting cycle.

For example, it is more convenient to recognize revenue when at the point when the invoice of sales has been sent to the customers and the related goods or supplied have been delivered or shipped or related services have been rendered.

Recognition of Sale of Goods

Revenue from the sale of goods should only be recognized when:

  • the significant risks and rewards of ownership are transferred to the buyer
  • seller lost the managerial involvement of the goods and passed it to the buyer
  • the revenue is measured reliably
  • it is probable that the economic benefits associated with the transaction will flow to the entity
  • the costs is measured reliably

If significant risks and rewards of ownership remain with the seller, the transaction is not sale and revenue cannot be recognized.

Recognition of Rendering of Services

When the outcome of a transaction involving the rendering of services can be estimated reliably, the associated revenue should be recognized by reference to the stage of completion of the transaction at the reporting date.

The outcome of a transaction is measured reliably when:

  • The revenue is measured reliably
  • It is probable that the economic benefits associated with the transaction will flow to the entity
  • The stage of completion at the reporting date can be measured reliably
  • The costs is measured reliably

When services are performed by an indeterminate number of acts over a period of time, revenue should normally recognized on a straight line basis. If one act is of more significance than the others, then the significant act should be carried out before revenue is recognized.

When the outcome of the transaction involving the rendering of services cannot be estimated reliably, revenue is recognized only to the extent of the expenses that are recoverable.

Journal Entries for Revenue Recognition

  1. When the revenue is earned but the customer will pay the money at a later date ( Commonly called “Credit Sales”):
Accounts Receivable A/cDebit
Revenue A/cCredit

2. When the Payment from the Customer is received in Cash/ by Cheque at later date (Against Credit Sales):

Cash/Bank AccountDebit
Accounts ReceivableCredit
(Being the credit sales amount is received)

3. When Sales is made at Cash (Customer’s Pays money at the time of delivery of Goods):

Cash/Bank AccountDebit
Revenue Account Credit
(Cash received from the customer at the time of Sales)

4. When Cash Deposit or Advance Payment is received before delivery of goods (Commonly Called “Advance against Sales”):

Cash/Bank AccountDebit
Unearned RevenueCredit
(Recorded cash received before delivery of goods)

** Unearned revenue is the liability of the company and to be shown in the Current Liability of Balance Sheet.

5. When after sales service is given for repair services:

Unearned Repair Revenue A/cDebit
Repair Revenue A/cCredit

For after sales services, there is not effect on income statement at the time of selling the goods. Revenue is recognized when the services have been performed. This entry reduces the unearned revenue account by the amount of revenue earned. At this point, revenue is recognized in the income statement account called repair revenue.

An illustration is given below for this point:

A Company is received an advance payment of $400 for repair services to be performed as follows: $300 in February and $100 in March. Since, the company is not rendered the service, hence the revenue against this receipt is not earned at the time when the payment is received. This is Advance received and will be recognized as a liability of the company. When the service will be rendered, the revenue will be recognized.

Cash AccountDebit400
Unearned Revenue A/cCredit.400
(Unearned revenue is accounted for)

Conclusion

According to Matching Concept revenue is recognized when this is earned, not when it is received. Again, expenses is recognized when expenses incurred, not when the payment is made. This is also called Accrual Accounting concept.

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