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Revenue: Revenue is the Income Generated from the sale of Goods and Services.
Recognition: Recognition is the Acknowledgment of Something’s Existence
Revenue Recognition: It is the Acknowledgment of Income.
Revenues are Recorded in the period within which they were Earned. This means that, regardless of when the cash is paid the Revenue will be recorded when the Goods or services has been delivered.
Revenue Recognition occurs in two ways:
1. Either the Service will be provided and then the Cash will be paid. (Accrued Revenue) –OR--
2. The Cash will be paid and then the Service will be provided. (Deferred Revenue)
Example 1:
In January, Tariq went to a farmer to purchase a wheat, but farmer hasn’t produced this Month. Tariq still willingly pays an advance in January. Now in February, Farmer has managed to prepare the wheat and handed over the produce to Tariq.
Q. Which Month should the Farmer Record his Revenue in?
A. February
This is because Farmer has not earned his Revenue in January. This is also an Example of Deferred Revenue. That is because the Cash was paid prior to the Service being provided.
Example 2:
In October, Tariq went to purchase a Laptop from his friend Farooq and tells that the Cash will be paid in the First Week of November. He Received the Laptop in October and Paid the Cash in the first week of November.
Q. Which Month should Farooq Record his Revenue in?
A. October
This is because, this is the month in which Farooq earned his Revenue. This is also an Example of Accrued Revenue. This is because, the Service was provided prior to the Cash being paid.
Summary:
1. Revenue is Recognized when it is Earned. NOT when Cash is Received.
2. When Cash is Paid in advance it is known as Deferred Revenue.
3. When Cash is Paid afterwards it is known as Accrued Revenue.
https://www.youtube.com/watch?v=0WP9Sht3ye4
https://www.youtube.com/watch?v=X-fiBTfSJ74
Accrual Basis Accounting
Under the accrual basis accounting, revenue is recognized as follows:
Revenue recognition: Revenue is recognized when both of the following conditions are met:
a. Revenue is earned.
b. Revenue is realized or realizable.
Revenue is earned when products are delivered or services are provided.
Realized means cash is received.
Realizable means it is reasonable to expect that cash will be received in the future.
Cash Basis Accounting
Under the cash basis accounting, revenues is recognized as follows:
Revenue recognition: Revenue is recognized when cash is received.
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Installment sales method and the Revenue Recognition Principle
Installment sales are quite common, where products are sold on a deferred payment plan and payments are received in the future after the goods have already been delivered to the customer. Under this method, revenue can only be recognized when the actual cash is collected from the customer.
Example:
In May, XYZ Company sold $300,000 worth of goods to customers on credit. In June, $90,000 was collected and in September, $210,000 was collected. The COGS is 80%.
Using the installment sales method, the journal entries would be:
May:
DR Installment Accounts Receivable 300,000
CR Deferred Revenue 300,000
DR Deferred COGS 240,000
CR Inventory 240,000
June:
DR Cash 90,000
CR Installment Accounts Receivable 90,000
DR Deferred Revenue 90,000
CR Sales Revenue 90,000
DR COGS 72,000
CR Deferred COGS 72,000
September:
DR Cash 210,000
CR Installment Accounts Receivable 210,000
DR Deferred Revenue 210,000
CR Sales Revenue 210,000
DR COGS 168,000
CR Deferred COGS 168,000
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An Example of Deferred Revenue
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Example: On May 1, 2010, Company A had a new lease contract with a tenant and received $6,000 for two month rent.
Revenue is recognized when Company A provides service. In
this example, service is provided when
time passes.
[Journal entry on May 1, 2010]
Unearned rent revenue is a liability account. Credit side of unearned rent revenue (a liability account) represents an increase.
"Unearned revenue" accounts represent the amount
of cash received before services are provided.
Since services have not been provided yet, it is not revenue.
"Unearned revenue" accounts are liabilities of
the company, because they should be paid back to the other
party if service is not provided in the future. [Journal entry on May 31, 2010]
Debit side of unearned rent revenue (a liability account) represents a decrease. Credit side of rent revenue (a revenue account) represents an increase.
[Journal entry on June 30, 2010]
Debit side of unearned rent revenue (a liability account) represents a decrease. Credit side of rent revenue (a revenue account) represents an increase. -----------------------------------------------------------------------------------------------------------------------------
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Cash (DR)
Revenue (CR) |
Cash (DR)
Unearned Revenue/Deferred (CR) |
Yes
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Did you get Paid?
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AR (DR)
Revenue Accrued (CR) |
No Entry
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No
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Yes
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No
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Did you do Work?
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Example:
ABC Company bids a Job
for 5000. The Customer accepts the Bill and pays a 2000 Cash Advance.
ABC Company Completes the job and bills the Customer for the Balance.
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