General Principle
A fundamental principle of accrual accounting is that revenue is recognised (reported on the income statement) when it is earned, so the company’s financial records reflect revenue from the sale when the risk and reward of ownership is transferred; this is often when the company delivers the goods or services. If the delivery was on credit, a related asset, such as trade or accounts receivable, is created. Later, when cash changes hands, the company’s financial records simply reflect that cash has been received to settle an account receivable. Similarly, in some situations, a company receives cash in advance and but delivers the product or service later, perhaps over a period of time. In this case, the company would record a liability for unearned revenue, or deferred revenue, when the cash is initially received, and revenue would be recognised over time as products and services are delivered. An example would be a subscription payment received in advance for cloud-based software delivered over a year.
Accounting Standard for Revenue Recognition
The core principle of the converged standard is that revenue should be recognized to “depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in an exchange for those goods or services.” To achieve the core principle, the standard describes the application of the following five steps in recognizing revenue:
- identify the contract(s) with a customer,
- identify the separate or distinct performance obligations in the contract,
- determine the transaction price,
- allocate the transaction price to the performance obligations in the contract, and
- recognise revenue when (or as) the entity satisfies a performance obligation.
The entity will recognize revenue when it is able to satisfy the performance obligation by transferring control of the good or service to the customer. Factors to consider when assessing whether the customer has obtained control of include the following:
- entity has a present right to payment,
- customer has legal title,
- customer has physical possession,
- customer has the significant risks and rewards of ownership, and
- customer has accepted the good or service.
