revenue recognition

Revenue recognition is the principle that determines when revenue is recorded in the accounting system.

Under accrual accounting, revenue is recognized when it’s earned — when the entity has fulfilled its obligation to the customer — regardless of when cash is received. This matters because the timing of revenue recognition directly affects reported profit on the income statement.

ASC 606 (under GAAP) and IFRS 15 established a five-step model [citation needed]:

1. Identify the contract with the customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price the entity expects to receive.
4. Allocate the transaction price to each performance obligation.
5. Recognize revenue when (or as) each performance obligation is satisfied.

A company that receives $120,000foraone-yearservicecontractdoes{n}^{\prime }trecognize$120,000 of revenue on day one. It recognizes $10,000permonthasitdeliverstheservice.Ondayone,thecompanyrecordscash(orareceivable)andaliability—deferredrevenue—representingtheobligationithas{n}^{\prime }tyetfulfilled.Eachmonth,asitperformstheservice,itdebitsdeferredrevenueandcreditsrevenuefor$10,000. An adjusting entry handles this allocation at the end of each period if the timing doesn’t align with the reporting calendar.

Related terms

• Accrual accounting — the accounting method under which revenue recognition operates.
• Income statement — the financial statement where recognized revenue appears.
• Adjusting entry — the entry used to record revenue earned but not yet billed, or received but not yet earned.
• GAAP — the accounting standards framework that includes ASC 606.
• IFRS — the international standards framework that includes IFRS 15.