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]:
- Identify the contract with the customer.
- Identify the performance obligations in the contract.
- Determine the transaction price the entity expects to receive.
- Allocate the transaction price to each performance obligation.
- Recognize revenue when (or as) each performance obligation is satisfied.
A company that receives $120,000 for a one-year service contract doesn’t recognize $120,000 of revenue on day one. It recognizes $10,000 per month as it delivers the service. On day one, the company records cash (or a receivable) and a liability — deferred revenue — representing the obligation it hasn’t yet fulfilled. Each month, as it performs the service, it debits deferred revenue and credits revenue for $10,000. An adjusting entry handles this allocation at the end of each period if the timing doesn’t align with the reporting calendar.