The revenue recognition principle, along with the matching principle, is an important principle in accrual accounting. It states that revenue should be reported when it is earned, or in cash accounting, when the cash payment is made. This helps to determine the accounting period, or the period of time in which revenue and expenses must be recorded.
General rules in the revenue recognition principle are that revenues are reported as soon as the goods or services being offered in exchange for payment have been completed. In some cases, they will be reported once the payment has been received and cleared, but this is not always the case. Cash received that has not been earned yet is not recorded as revenue but as a liability. This means that this money is not recorded as a cash payment until the services being offered have been provided to the customer.
There are four types of revenue which must be recorded as stated in this principle. The first is cash payments given in exchange for goods. This would be recorded on either the date the sale is made or the date of delivery. The second is revenues earned from doing services for a client and they are recorded when those services are complete and billed. Revenues from borrowing the company’s assets or money earned from selling company assets must also be recorded.
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Exceptions to the revenue recognition principle include inventory sold with a buyback agreement or with a return policy in place. In either case, the transaction can not be complete until the buyback or return period has passed since there is no way to determine which a return will be made on an item. Long-term contracts are another exception, as they take time to complete even when cash is paid in advance. Sometimes money will be paid and recorded as various intervals during a large project, other times the transaction is recorded once the work is complete.
In some cases, the revenue recognition principle states that revenues must be recorded even before any sale has been made. In agriculture, for instance, revenues must be recorded at harvest time because there is a constant market for food items, the prices are fairly stable and assured, and distributing goods does not cost much. These stipulations must be present in order for revenues to be counted before an actual sale.