Revenue recognition principle - What is the revenue recognition principle?
In accrual accounting, the revenue recognition principle states that companies should record their revenues when they are recognised or earned (regardless of when the cash is actually received).
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The revenue recognition touches on the same grounds as the matching principle in the sense that activity should be recorded in the time period that it occured. The revenue recognition principle is merely specific towards recording revenues in the correct accounting period, whereas the matching principle is specific towards recording expenses in the correct accounting period.
What does the revenue recognition principle mean?
The revenue recognition principle only applies to accrual accounting), which means you should record the revenue when it is ‘realised’, which could be before you have received payment. On the other hand, in cash accounting you would only record the revenue once the cash has been received.
When we talk about revenue being ‘realised’, we mean that the goods/services have been received, and the payment for those goods/services are still expected. In other words, earned or ‘realised’ revenue applies to situations where you have delivered goods, or completed a service.
Example of revenue recognition principle
- A consulting company provides it services to one of their clients for £3,000 in the month of January 2018.
- The client does not pay for the consulting time until the June 2018 (6 months later that year).
Solution: According to the revenue recognition principle, the consulting company should record the revenue of £3 000 in their accounting books in January 2018 (as opposed to June 2018), since this is when the revenue was realised.
Revenue recognition principle and accounting principles
Accounting principles are laid out in order to provide a universal way to communicate economic information in a language that can be understood from one business to another.
Therefore it is important to comply with these accounting principles to ensure that your business is recording all financial information correctly, following the Generally Accepted Accounting Principles (UK GAAP). These principles provide a standard on how economic events should be recognised, recorded, and presented.