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Revenue recognition is an accounting methodology that is used to identify the particular circumstances by which income is recognized as revenue with the accounting records of the recipient. This principle or methodology is considered one of the generally accepted accounting principles that many businesses and other organizations utilize in order to keep their accounting records accurate and current. This recognition of revenue that has become income usually requires the occurrence of some specific event that results in making it possible to measure the revenue and record it in the accounting books, so that it is identified as income.
For many businesses, revenue recognition takes place when a payment is received from a customer. By this point, the company has filled the order for goods or services placed by the customer, and has either delivered the products, or has processed the order and arranged for the shipment of the products to the customer. In return, the customer has remitted payment for the order. By posting the receipt of that payment into the accounts receivable section of the accounting records, the business has recognized the receipt of that revenue, and now counts it as income.
There are variations on this basic model of revenue recognition. A company may choose to use the date that the order is placed, or the date that the invoice for the order is generated, as the key event that leads to recognition. For businesses where the possibility of the customer returning products is somewhat high, the key event may be the passing of the period where the customer can actually return those products, rather than either the invoice date or the date that payment is received. Each of these approaches is considered viable, and may be used as long as the business maintains a consistent approach to revenue recognition as it relates to all its sales activity.
While there are some questions about the ethics of adjusting revenue recognition in order to present a more positive image to investors or the general public, the fact is that the process of making that adjustment is relatively easy. For example, if a company normally recognizes revenue when payment is remitted, and it currently has a large amount of outstanding customer invoices, the company may choose to alter how it recognizes revenue. In this scenario, instead of recognizing the revenue when it is submitted by the customers, the business chooses to recognize the revenue as of the dates that the invoices were prepared. The end result is that the business posts higher sales and income figures than would have been possible otherwise.