I. What is Revenue Recognition?

The Matching Principle
The matching principle of GAAP dictates that revenues must be matched with expenses. Thus, income and expenses are reported when they are earned and incurred, even if no cash transaction has been recorded.

For example, say a company made a sale for $30,000 within an accounting period but has not received payment. Even though the company was not paid, the sale is recorded as revenue. This revenue has to be matched with the expenses that the company incurred in the accounting period to generate that revenue (revenues and expanses must match).

If revenues were not matched with their related expenses, companies would produce financial statements that provide little information to the readers and themselves. (This is a fundamental principle of accrual-basis accounting)

Revenue-Recognition Principles
SFAS 5 specifies that two conditions must be met for revenue recognition to take place:

  1. Completion of the Earnings Process
    This means the company has provided all or virtually all of the goods and services for which it is to be paid. Furthermore, it means the company can measure the total expected cost of providing the goods and services, and the company must have no significant remaining obligations to its customers. Both must be true for this condition to be met.
  2. Assurance of Payment
    There must be a quantification of the cash or assets that will be received for realized goods and services. Furthermore, the company must be able to accurately estimate the reliability of payment. Both must be true for this requirement to be met.

Gross and Net Reporting of Revenue
Under gross revenue reporting, sales and the cost of goods sold are reported separately. With net revenue reporting only the net revenue, calculated by subtracting cost of goods sold from gross sales, is reported. Since the only the net revenue is reported, revenues will be less than under gross revenue reporting.

Under U.S. GAAP, a firm using gross revenue reporting must be the primary party to any contract, take on both inventory and credit risk, be able to choose its suppliers, and have the ability to set price.

When analyzing the financial statements analysts should be aware of how aggressive or conservative a firm's revenue recognition policies are. A firm's that has a very aggressive revenue recognition policy runs the risk of over stating its revenues and its earnings performance. Analysts should also be aware of any assumptions or judgments that are made in reporting revenues



Revenue Recognition Methods and Implications

Related Articles
  1. Investing

    Understanding Revenue Recognition

    Revenue recognition is an accounting term describing how and when a company records revenue in its accounting records.
  2. Managing Wealth

    Revenue Analyst: Job Description & Average Salary

    Learn what a revenue analyst does and what skills are needed to succeed in the position. Determine the education and experience required to work in this field.
  3. Investing

    New Accounting Rules To Accelerate Revenue Recognition

    An FASB accounting standards change will lead to accelerated revenue recognition for many companies, providing a much-needed boost during sluggish economic growth.
  4. Investing

    What does Deferred Revenue Mean?

    Deferred revenue is advanced payments received by a company for products or services that it has not yet rendered or shipped. Another term for deferred revenue is unearned revenue. Whereas normal ...
  5. Investing

    How Do Companies Calculate Revenue?

    Revenue is the money a company receives in exchange for its goods and services.
  6. Investing

    Understanding Cost of Revenue

    The cost of revenue is the total costs a business incurs to manufacture and deliver a product or service.
  7. Personal Finance

    Common Interview Questions for Revenue Analysts

    Learn more about the role that a revenue analyst plays in a company and common questions asked during job interviews for this position.
  8. Investing

    S&P 1500 Index: A Revenue Case Study

    Learn what comprises the S&P 1500 and how analysts use revenue trends to benchmark against the performance of a portfolio or single stock investment.
  9. Investing

    Understanding the Top Line

    Top line refers to a company’s gross sales without any reductions for discounts or returns.
  10. Trading

    World's Top 10 Trading Companies

    Which are the top trading firms of the world? Here is the list of the ones with highest trading revenue.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center