revenue recognition

When to Recognize Revenue

Revenue recognition is one of the most important concepts in accounting. Deciding when to record revenue and expenses can have a huge impact on the financial statements. Incorrectly recording revenue that has not been earned can inflate profits and give potential investors or lenders incorrect information about the company’s future profitability.

Revenue should be recorded when it is earned, essentially when the work is done. For some businesses, this is fairly simple. When I complete a tax return for a client, I have earned revenue. When a retailer sells a product, revenue is earned. It does not matter when payment is received; the work is completed and therefore the revenue should be recorded. Payments do not affect the recognition of revenue.

When deciding how to record transactions involving revenue, there are two important questions you should ask yourself:

  1. Did the company do the work?
  2. Did the company get paid?

The following chart should help guide you through the process of determining if revenue should be recognized.

 Rev1

Notice the first question is regarding the work. This is the most important factor. Once we have determined it work has been done, then we can look at payment information to determine what the debit should be in the entry.

Let’s look at some examples.

K’s Bounce House Adventures rents bounce houses to individuals and corporations for parties. K’s has the following transactions during the month of February. Record the necessary journal entries.

Feb 2 – K’s agrees to provide a bounce house for a corporate function on February 10 for $300. The companies sign a contract stating that payment will be made on the date of the function.

Feb 4 – K’s provides a bounce house for a birthday party and gets paid at the end of the party, $250.

Feb 5 – K’s provides two bounce houses for a town picnic, $700. K’s must bill the town and will receive payment within 30 days.

Feb 7 – K’s signs a contract to provide a bounce house for a birthday party on Feb 20 for $350. The contract requires the customer to pay 50% of the balance today and the rest the day of the party.

Feb 10 – K’s provides the bounce house for the contract signed on Feb 2 and is paid.

Feb 13 – K’s provides a bounce house for a function booked in January. The customer paid the entire amount of the contract, $275, when the function was booked.

Feb 20 – K’s provides the bounce house for the contract signed on Feb 7 and is paid the remaining balance.

Feb 25 – K’s receives the payment from the town event on Feb 5.

For each of the transactions, ask yourself the two questions above. The solutions are listed below with explanations. Try working through the transactions before looking at the solutions. Take notes on the transactions you had trouble identifying. Usually there is a pattern. Find your weaknesses and work on them. Write your own transactions for those types of entries.

Click here for the solutions to the transactions.

Related Videos:

Revenue Recognition

Basic Journal Entries, Part 1

Basic Journal Entries, Part 2

Share This:


Related pages


indirect method of cash flowsfifo perpetual inventory systempercentage sales calculatorentry for accrued expensescash book reconciliation templateyear end adjustments journal entriesbad debt expense on income statementcalculating interest rate on a loan formulahow much is semiannuallyhow to calculate overheadsfreight in journal entryaccruals accounting entriescalculating asset turnovercost of goods sold restauranthow to calculate finished goods inventoryprofit margin asset turnovermixed equations calculatorexamples of target costingaccrued interest journal entrycost pool and cost driver exampleshow to treat disposal of fixed assetwhat is a fixed expensedepreciation declining balancepremium bonds cash outentry for prepaid expenseaccounting merchandising businesstransit checks definitioninterest expense journal entrystatement of corrected net profituncollectible accounts definitioncost ratio calculatorwhat is current assets and current liabilities with exampledefinition of deposit in transitincome statement contribution margin formatplant accountant salaryincome statement with percentagestax accounting textbookprepaid insurance iscalculate predetermined overhead ratework out gross profit marginperpetual discountinterest expense adjusting entrydiscount on bonds payable on balance sheetasset turnover calculationwhat is ending inventoryjournal entry for bad debt expensehow to calculate job costingfactory overhead variance formulasalvage value of car calculatorcalculate contribution margin per unitapplied factory overheadaccrued expenses journal entrygraph slope calculatorwhat is the difference between debit and credit accountingaccrued interest journal entryaccumulated depreciation equationcogs formula accountingemployer paye calculator360 day loan calculatoradjusting entry depreciationvariable cost of goods sold formulacar loan accounting entryprepayment accountinghow do you calculate ending inventoryexample indirect cash flow statementloan accounting journal entrieshow to compute bad debt expensehow to calculate an annuity factoractual manufacturing overheadchanges in accounts receivablesdifference between cost centre and profit centreaccrual of interest expenseretained earning debit or creditincremental sales calculationoverhead calculation formulajournal entry for cheque receiveddouble decline balance depreciationjournalizing bank reconciliationmerchandising firminventory adjustment journal entrynormal balance of expenseinvestment in bonds journal entrytraditional income statement managerial accountingmake or buy decision example accountingannuities calculationshow to calculate state withholding taxclassified income statement template