Revenue recognition principle

The revenue recognition principle states that one should only record revenue when it has been earned, not when the related cash is collected. For example, a snow plowing service completes the plowing of a company's parking lot for its standard fee of $100. It can recognize the revenue immediately upon completion of the plowing, even if it does not expect payment from the customer for several weeks. This concept is incorporated into the accrual basis of accounting.

A variation on the example is when the same snow plowing service is paid $1,000 in advance to plow a customer's parking lot over a four-month period. In this case, the service should recognize an increment of the advance payment in each of the four months covered by the agreement, to reflect the pace at which it is earning the payment.

If there is doubt in regard to whether payment will be received from a customer, then the seller should recognize an allowance for doubtful accounts in the amount by which it is expected that the customer will renege on its payment. If there is substantial doubt that any payment will be received, then the company should not recognize any revenue until a payment is received.

Also under the accrual basis of accounting, if an entity receives payment in advance from a customer, then the entity records this payment as a liability, not as revenue. Only after it has completed all work under the arrangement with the customer can it recognize the payment as revenue.

Under the cash basis of accounting, you should record revenue when a cash payment has been received. For example, using the same scenario as just noted, the snow plowing service will not recognize revenue until it has received payment from its customer, even though this may be a number of weeks after the plowing service completes all work.

Similar Terms

The revenue recognition principle is also known as the revenue recognition concept.

Related Courses

Accountants' Guidebook 
Bookkeeping Guidebook
Revenue Recognition