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Accounting Information > Accounting and Terminology > Revenue
Revenue and Expense Recognition

Normally, revenue is recognized when the earning process is practically complete and when an exchange transaction has occurred. This is known as the revenue recognition principle. The usual exchange transaction that occurs is a sale of a product or a service. Sometimes other indications that revenue has been earned are used, and then some other methods of revenue recognition may be employed. Some examples of these other methods are the percentage of completion approach, the end of production method, and the receipt of cash basis.

 

The percentage of completion approach to revenue recognition is used for some long-term construction contracts. The justification for this method is that revenue is substantially earned at various stages of the construction process. In order to be able to use the percentage of completion method, you must be able to determine reliable estimates of costs and progress.

The end of production approach is when revenue is recognized prior to the sale, but after production is completed. This method is only feasible when the price is certain. An example of this is the mining of some minerals that have a standard price.

The receipt of cash approach is used when collection is uncertain at the time of the sale. Normally, installment payments are required over an extended period of time. This method is sometimes used in the retail field for sales on the installment basis, due to the risk that the receivable may never be collected.

Service transactions can have their own revenue recognition questions. Generally, the revenue related to a service is recognized when the seller performs the service transaction. There are four methods used for service revenue recognition. They are the specific performance method, the completed performance method, the proportional performance method, and the collection method.

The specific performance method is used when the service transaction is for a single act. The completed performance method is used when the service transaction is for more than one act, and when the proportion of the service to be performed in the last of the acts is such a major part of the entire transaction that performance would not be considered to have occurred until the last act occurs. The proportional performance method is used when the service transaction is for more than one act, and when revenue should be recognized in proportion to the occurrence of each act. The collection method is used when there is considerable uncertainty about the collectibility of the revenue. For this reason, the revenue is not recognized until the cash is collected.

Generally, expenses should be reported in the period in which the revenue they are associated with is being recognized as earned. Any indirect costs should be expensed when incurred with no regard to the revenue recognition of the related transaction. The idea of matching expenses with the related revenue is called the matching principle.

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