Revenue recognition is an accounting principle that determines when a company should count its revenue as earned.
This sounds simple, but the point at which revenue is actually recognized can vary depending on your industry, product or service you provide, and even your geographical location. For instance, one of the biggest misconceptions is confusing revenue recognized with cash payments collected. Depending on what you sell, your revenue might be recognized well before you actually receive any cash from the customer.
The method used to determine revenue recognition can vary. Still, looking at generally accepted accounting principles (GAAP), we can see the 5 steps required for many U.S. companies to calculate recognized revenue:
- Identify the contract with the customer
- Identify the performance obligations
- Determine the price for the transaction
- Allocate this agreed-on transaction price to the performance obligations
- Revenue is recognized when the provider satisfies their performance obligation
You can see that none of these points specify that cash must be transferred for the revenue to be recognized. For merchants selling products, the performance obligation is often complete when they provide the product, and this is the same time they receive a cash payment. But there could be products or services which are provided to the customer well before payment is received. In this case, the point at which that revenue is recognized will be earlier than the seller receives the payment. Conversely, some providers might receive a downpayment for their product or service. This payment does also not count as recognized revenue since the performance obligations have not been satisfied yet.