The question of when to recognize revenue can be a challenge for accountants, companies and their CPAs. Revenue recognition is a process to ensure that the company recognizes and reports revenue in accordance with Generally Accepted Accounting Principles (GAAP). Generally speaking, revenue is recognized when the revenue can be objectively, reasonably and accurately determined. GAAP rules relating to revenue recognition are complex and are affected by a variety of factors, including but not limited to:
- At what point title and risk of loss pass from seller to buyer and/or
- Whether delivery of products has occurred and/or
- Whether any provision of services has happened and/or
- Whether or not the selling price is fixed or determinable and/or
- Whether or not collection or collectability is relatively certain and/or
- Whether the entire order requested by the buyer was delivered and/or
- If there is an arrangement calling for payment based on a percentage of completion method, and/or
- If the transaction involves services whether all of the required services have been completed
Under the matching principle, when revenue is recorded by a company it must also record (at the same time) any expenses related to that revenue. To do otherwise would result in overstated earnings as a result of under reported expenses in a particular accounting period.
The matching principle requires decisions by a company's accountants and auditors and management relating to the timing of expenses, and the recognition of revenue. The matching principle's main guidance is to first determine revenue and then match all costs associated with generating that revenue. While matching revenues and expenses is usually straightforward, there are instances in which doing so requires careful analysis. In other words, while usually straightforward this process occasionally involves a certain amount of uncertainty.
Fortunately, Generally Accepted Accounting Principles (GAAP) provides auditors and others with helpful guidance relating to how to apply the matching principle. As a result, these issues are usually resolved through research rather than relying on subjective decisions.
Copyright 2010 by Michael C. Dennis. All Rights Reserved.