Revenue is the most critical and mutual concern for any organization and its investors. It helps to assess the direction of the company and all the financial decisions are based on its projection. Typically there are two standards for revenue recognition via the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
The both contradict a bit and have a room for improvement. The standards issued as ASU 2014-09 by FASB and IFRS 15, Revenue from Contracts with Customers, by the IASB gave converged guidelines in order to recognize revenue by the entities. This new guidance is regarded as a milestone in efforts to enhance the process of financial reporting.
Under the revenue recognition principle, the revenue isn’t recognized as revenue until unless earned. For example, if service has not been provided and the payment has been made in advance.
The amount received will be recorded as advance payment only when the service will be given it will be recorded as revenue. Another example to simplify the understanding is even the payment has not been made but the service has been provided the amount is deemed as revenue. This principle of value recognition is also called value recognition concept.
Breaking down the process the revenue is not recognized until it’s realized regardless of the payment. It’s only recorded when the services against it have been given. The key difference between realization and recognition is that the former means to a conversion of non-cash resources like service or product for cash and the latter is about recording the cash received against such service or product as revenue. This is a crucial accounting concept where revenue is recorded regardless of its receipt.
Different companies or industries have varying approaches to revenue recognition. When there is a long-term relationship between the client and service provider like in defense agreements or construction contracts which take minimally 5 to 10 years to complete the revenue is recorded in bits every time with the completion of the specific part of the job.
The other category of companies recognize revenue right the completion of manufacturing but before there are any actual sales made. Oil, mining, natural gas pipelines and agricultural companies use this mode of revenue recognition. The last category of companies recognizes revenue once it’s been received. Most companies making installment sales use this method of revenue recognition.
Key Difference between US GAAP and IFRSs
The US GAAP recognizes any payment under the revenue head only when it’s earned. The IFRS recognizes revenue at any event that ensures the flow of income to the business or any activity that will result in an increment of cash.
Definition of revenue
Paragraph 78 of FASB defines revenue as the increase in the inflow of assets of the company by rendering any service, manufacturing and delivering a product that stands as the central operation of the company.
Under the IFRS principle, revenue is recorded against any activity regarded as sales, rent, royalties, dividend or fees. It generally includes all economic benefits that a company earns during the course of its financial year.
Sale of goods
Under the GAAP principle, the revenue from sales is recognized only after the service is provided. Following are the conditions to get any income register as revenue
- There is an evidence of the arrangement ( the activity of sale).
- The exchange (delivery of the product or service) has been done.
- The price against the sale is predetermined and fixed.
Paragraph 78 of FASB Concepts Statement No. 6, Elements of Financial Statements, defines revenue as “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.”
The IFRS principle recognizes sale of goods in the following conditions
- The ownership of the goods has been transferred.
- The entity has no control over the goods sold.
- There is a probability that the economic benefits will flow to the company with regards to the transaction.