Understanding Revenue Recognition and How to Account for it

Keywords – Revenue Recognition

Revenue, costs, and profits form the financial basis for any organisation.

Generally, businesses have a relatively clear understanding of what accounts for costs and profits. However, from an accounting perspective, revenue recognition needs some further explanation.

Revenue Recognition

As indicated by the term, revenue recognition is an accounting principle that determines whether or not the revenue generated by an organisation is recognised or not. However, the actual recognition of revenue may differ from one sector to another.

For example, a lawyer may charge by the hour. However, a construction company may charge a percentage of the budget. Therefore, how revenue is standardised follows certain standards.

In the UK, these standards are set by the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB). Please keep in mind that IASB and FASB, on a relatively regular basis, update the revenue recognition standards to keep up with the market.

The said standards are applied to both International Financial Reporting Standards (IFRS) and the more well-known Generally Accepted Accounting Principles (GAAP). We will cover these topics in coming blogs.

For industry specific guidelines, please check the resource here.

At a collective level, the following standards are applied:

  1. Establishing the contract
  2. Establishing contractual obligations
  3. Actuating the amount of transaction
  4. Allotting the actuated amount of transaction to the contractual obligations
  5. Recognising revenue when the performing party fulfils the obligations

Considerations for Accounting Period

It should be kept in mind that revenue is only recognised from the moment of earning and not necessarily at the point of receiving. 

In other words, in order for the revenue to be recognised, an acceptance of the fulfilment of an obligation is considered as the revenue recognition point, even if the payments have not been made yet. Therefore, this is different from earned revenue, that accounts for the actual crossing of both payments and fulfilment of obligations. 

From an accounting period perspective, the revenue generating activity must be completed, either fully or considerably, in order to be declared, with a reasonable certainty that revenue will be earned. While doing so, you must include any associated costs during the same accounting period.

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