What is the revenue recognition principle?

The revenue recognition principle, along with the matching principle, is an important principle in accrual accounting. Establishes that income must be declared when obtained, or on a cash basis, when payment is made in cash. This helps to determine the accounting period or time period in which income and expenses should be recorded.

The general rules in the principle of revenue recognition are that revenue is reported as soon as the goods or services offered in exchange for payment are completed. In some cases, they will be reported as soon as payment is received and cleared, but this is not always the case. Cash received that has not yet been earned is not recorded as income but as a liability. This means that this money is not recorded as a cash payment until the services offered have been provided to the customer.

There are four types of revenue that must be recorded as set out in the revenue recognition principle. The first is cash payment given in exchange for goods. This would be recorded on the date of sale or the date of delivery. The second is revenue earned from performing services for a customer and is recorded when those services are completed and billed. Income from borrowed company assets or cash obtained from the sale of company assets should also be recorded.

Exceptions to the revenue recognition principle include inventory sold under a repurchase agreement or with an established return policy. In either case, the transaction cannot be completed until the buyback or return period has passed, as there is no way to determine which return will be made on an item. Long-term contracts are another exception, as they take time to complete even when the money is paid in cash. Sometimes the money will be paid and posted at various intervals during a large project, other times the transaction is posted after the work is complete.

In some cases, the revenue recognition principle states that revenue must be recorded even before any sales are made. In agriculture, for example, income must be recorded at harvest time because there is a constant food market, prices are quite stable and safe, and distribution of goods does not cost much. These stipulations must be present in order for the proceeds to be counted before an actual sale.