The revenue recognition principle, a characteristic of accrual accounting, mandates that revenues are recognized on the income statement in the period when realized and earned—not necessarily when cash is received. Realizable indicates that the consumer has obtained products or services, but payment for the good or service is expected later. Earned revenue accounts for products or services that have been given or performed, respectively.
The revenue-generating activity must be wholly or substantially complete to be recognized in revenue within the appropriate accounting period. Also, there must be a sufficient level of assurance that earned income payment will be paid. Lastly, according to the matching principle, the revenue and related expenditures must be reported in the same accounting period.
IFRS REVENUE RECOGNITION STANDARD
A business recognizes revenue by IFRS 15 when promised goods or services are transferred to a customer and are valued at an amount representing what the entity expects to be entitled in return for such goods or services.
A company must follow the following five procedures to account for revenue by IFRS 15:
- Find out what contract(s) you have with a particular customer.
- Determine the contract’s responsibilities for performance. Promises in a contract to transmit specific products or services to a client are known as performance obligations.
- The price at which the transaction will be completed an organization expects to receive a certain amount of money in exchange for transferring promised products or services to a client. This is known as the transaction price. Because consideration provided in a contract might be uncertain, an entity must estimate how much it expects to receive in return for transferring the promised products or services to the client.
- Assign the deal’s transaction price based on each product or service stand-alone selling price to each performance obligation.
- In the event of the transfer of promised goods or services to customers, revenue should be recognized (which is when the customer obtains control of that good or service). Obligations of performance might be fulfilled at a single moment or over time. This is usual for goods-to-customer transfers (typically for promises to transfer services to a customer). One option is to use an acceptable measure of progress to calculate the amount of revenue that should be recognized when a performance obligation is fully met over time.
FIVE CRITERIA FOR REVENUE RECOGNITION IFRS
- The contract can be identified by:
- Identify distinct responsibilities for performance
- Choose a price for the transaction
- Allocate the transaction price to the responsibilities to execute
- In the event of successful completion of all performance obligations, recognize revenue.
JOURNAL ENTRY TO RECORD REVENUE
- If the transaction is for cash, debit the sale’s cash receipts account before crediting sales revenue in the accrual journal entry. Revenue collected will be included in sales revenue in the current accounting period’s income statement.
- Shipping conditions determine when revenue is recognized when the transfer of ownership of the goods does not occur immediately, and delivery of the items is required. Fob and FOB Shipping Point are the standard shipping terms.
- The firm should only recognize revenue when the right of return has expired if it cannot reasonably predict future returns and has exceptionally high rates of returns on sales.
HOW REVENUE RECOGNITION AFFECT THE INCOME STATEMENT
Businesses that follow GAAP, or generally accepted accounting standards, utilize accrual accounting. Because business activities and transactions are recorded in the company’s books on an accrual basis rather than based on when cash is exchanged, the ensuing financial statements are more accurate and consistent. Although the cash method of accounting is suitable for many small firms, some may require or choose to utilize the accrual approach in order to properly track their costs.
Revenues must be recognized in accordance with the revenue recognition principle, which is a characteristic of accrual accounting, according to GAAP (generally accepted accounting standards). This means that revenue is recorded on the income statement in the period in which it is realized and generated, rather than when cash is received.