The revenue recognition principle in accrual accounting requires income to be reported when earned, or when cash payment is made. Revenue is recorded when goods or services are completed, and exceptions include repurchase agreements and long-term contracts. In some cases, revenue must be recorded before a sale is made, such as in agriculture.
The revenue recognition principle, along with the matching principle, is an important principle in accrual accounting. It establishes that income must be reported when it is earned, or in cash accounting, when the cash payment is made. This helps determine the accounting period, or the period of time in which income and expenses must be recorded.
The general rules on the revenue recognition principle are that revenue is reported as soon as the goods or services 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 yet been earned is not recorded as income but as a liability. This means that this money is not recorded as a cash payment until the services offered have been provided to the customer.
There are four types of income that must be recorded as set out in this principle. The first is cash payments given in exchange for goods. This would be recorded on the date the sale is made or on the delivery date. The second is revenue earned from providing services to a customer and is recorded when those services are completed and invoiced. Proceeds from borrowing the company’s assets or money earned from the sale of the company’s assets must also be recorded.
Exceptions to the revenue recognition principle include inventory sold under a repurchase agreement or with a stated return policy. In either case, the transaction cannot be completed until the buy-back or return period has passed, as there is no way to determine what return will be made on an item. Long-term contracts are another exception, as they take time to complete even when cash is paid up front. Sometimes money will be paid and posted at various intervals during a large project, other times the transaction is posted after the work is complete.
In some cases, the revenue recognition principle states that revenue must be recorded even before any sale is made. In agriculture, for example, income must be recorded at harvest time because there is a constant market for food, prices are quite stable and secure, and the distribution of goods does not cost much. These stipulations must be present for proceeds to be counted prior to an actual sale.
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