Loading the player...

What is 'Revenue Recognition'

Revenue recognition is an accounting principle under generally accepted accounting principles (GAAP) that determines the specific conditions under which revenue is recognized or accounted for. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue is measurable. However, there are several situations in which exceptions may apply.

BREAKING DOWN 'Revenue Recognition'

Revenue is at the heart of business performance. Everything hinges on the sale. As such, regulators know how tempting it is for companies to push the limits on what qualifies as revenue, especially when not all revenue is collected when the work is being done. Lawyers tend to bill clients in billable hours and present the bill after the case is completed. Construction managers often bill clients on a percentage-of-completion method. As a result, analysts like to know that revenue recognition policies for a company are relatively standard for the industry. This also helps to ensure an apples-to-apples comparison is being made between metrics using line items from the income statement.

Revenue Recognition Examples

If you pay for a candy bar with cash, it is considered a sale. If you pay for the candy bar with a piece of Monopoly money, it is not considered a sale. So, for example, assume Sue the store owner must report sales to her investors and knows that revenue is not the same as cash on paper. Sue is desperate to look good on paper, so she takes the Monopoly money and recognizes it as revenue. Investors think the company has positive earnings, but the revenues aren't real. Thankfully, investors are protected against such a scenario for many reasons, one of which is because there are certain rules about recognizing revenue to prevent managers like Sue from recording a fake sale.

Revenue recognition states that revenue should not be recorded until it is earned. However, not all sales are made in cash. The speed with which credit sales become cash is also a critical component of revenue recognition.

The classic case of misguided revenue recognition is a furniture company that is having a bad year. As a promotional gesture, the manager extends credit terms with no money down. The furniture company sells out of furniture and recognizes sales as revenue on the income statement, but the manager received no cash. The company is revenue-rich and cash-poor.

GAAP Changes to Revenue Recognition Policies

On May 28, 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly issued Accounting Standards Codification (ASC) 606, regarding revenue from contracts with customers. ASC 606 provides a uniform framework for recognizing revenue with contracts. The old guidance was based on industry specific guidance, which created a system of fragmented policies. The new guidance is industry-neutral and therefore more transparent. Most companies have until 2018 to implement changes.

RELATED TERMS
  1. Revenue

    The amount of money that a company actually receives during a ...
  2. Marginal Revenue - MR

    The increase in revenue that results from the sale of one additional ...
  3. Accrued Revenue

    An asset class for goods or services that have been sold or completed ...
  4. Operating Revenue

    Income derived from sources related to a company's everyday business ...
  5. Deferred Revenue

    Advance payments or unearned revenue, recorded on the recipient's ...
  6. Accrual Accounting

    Accrual accounting is an accounting method that measures the ...
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. Personal Finance

    Revenue Analyst: Career Path & Qualifications

    Learn more about the duties of a revenue analyst and the qualifications needed for the position, along with the career path for these professionals.
  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

    S&P 500 Index: A Revenue Case Study

    Discover the breakdown of aggregate total revenue of S&P 500 companies, including how much revenue is earned by country, industry and geographic location.
  6. Small Business

    What's Marginal Revenue?

    In microeconomics, marginal revenue is the additional revenue generated by increasing sales revenue by one unit. Another way of saying this is that the marginal revenue is the revenue generated ...
  7. Investing

    Creative Accounting: When It's Too Good To Be True

    Accounting practices have matured, but there are still plenty of ways that companies can disguise their financial results.
  8. Investing

    What Is The Difference Between Revenue And Income?

    The average person uses revenue and income in interchangeable ways. But these terms refer to very specific, and different, concepts.
  9. Investing

    What is Operating Revenue?

    Operating revenue is income that’s derived from sources related to a company’s everyday business operations.
  10. Investing

    How Do Companies Calculate Revenue?

    Revenue is the money a company receives in exchange for its goods and services.
RELATED FAQS
  1. What are the FASB guidelines surrounding revenue recognition?

    Find out how the Financial Accounting Standards Board regulates a firm's ability to recognize revenue to promote accuracy ... Read Answer >>
  2. How is deferred revenue treated under accrual accounting?

    Learn deferred revenue and its treatment under accrual accounting and why various revenue recognition methods result in different ... Read Answer >>
  3. What are the advantages and disadvantages of horizontal integration?

    Understand the criteria for recognizing revenue recognition. Learn the principles behind when a company can consider its ... Read Answer >>
  4. What is the difference between revenue and sales?

    Learn to distinguish between a company's revenue and its sales, and see why the distinction is important when analyzing a ... Read Answer >>
  5. When should a company recognize revenues on its books?

    When a company makes revenues from its operations, it must be recorded in the general ledger and then reported on the income ... Read Answer >>
  6. What types of revenue are taxable?

    Learn about all the various types of taxable corporate revenue and how different revenues are designated and differentiated ... Read Answer >>
Hot Definitions
  1. Cash Flow

    The net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company's ...
  2. PLUS Loan

    A low-cost student loan offered to parents of students currently enrolled in post-secondary education. With a PLUS Loan, ...
  3. Graduate Record Examination - GRE

    A standardized exam used to measure one's aptitude for abstract thinking in the areas of analytical writing, mathematics ...
  4. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  5. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  6. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
Trading Center