ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Revenue Recognition: The Basics You Need to Know

Updated on July 28, 2020
zkabir88 profile image

Zunaid is currently a Business student at ASU W.P. School of Business. He also has dual degrees in History and Political Science from ASU.

In the Accounting field, revenue is recognized when a performance obligation is satisfied. This is the core fundamental principle of revenue recognition as we know it. However, there are instances when it is permissible for individuals and business entities to recognize revenue over a period of time. This is because, we have to account for the fact that the fair values of assets and liabilities change over time. In simple words, a dollar today is not worth the same, say, in 10 or 20 years from now. Yet, in other occasions, individuals and business entities are allowed to recognize revenue at the point of sale, as long as they follow the proper Generally Accepted Accounting Principles (GAAP) for revenue recognition, implemented by the Financial Accounting Standards Board (FASB).

Having said all of that, we will now briefly discuss about two of the most common revenue recognition methods:

(1) Revenue recognition when performance obligation is met.

(2) Revenue recognition over a period of time during a long-term financial project.

We will elaborate on these two methods further with some simple, yet easily-comprehensible, real life examples.

Method 1: Recognizing Revenue after Performance Obligation is Met

Generally, revenue is often recognized at the time of the sale, because this is when the actual sale of the goods or services is complete. At this point, we have satisfied our earning process by completing a sales transaction. However, we have to remember that we have not really “earned” the revenue (i.e. unearned revenue) just by completing our sales of good and services to our customers. We will only earn the revenue, when the customers have the legal possession of the goods and services, and are legally responsible for them. At that crucial stage, then, we have truly met our service obligations to the customers and we can recognize our sales or service revenue appropriately.

A real life example of this would be buying an airline ticket from Jet Blue Airways and flying to New York. When we book and pay for an airline ticket online or in person, Jet Blue has completed their sales obligations and process of earnings. However, we, as customers, have not received Jet Blue’s actual service yet until the day of the flight. The airlines company has not really “earned” their service revenue, even though, they have completed the sales. Jet Blue Airways will only truly recognize their service revenue, when we have actually boarded their plane from Sky Harbor International Airport, and actually landed at JFK at the end of our flight.

Method 2: Recognizing Revenue over a Period of Time Intervals

It is appropriate to recognize revenue over a period of time in intervals if a long-term contract of service has been agreed upon between the buyer and the seller. Based on mutual agreement, a seller can charge a buyer a certain cost and transfer the title of ownership of certain number of units of goods at a certain completion stage of the contract, even though the entire contract obligation has not been met. The seller can recognize revenue when the goods are delivered to the buyer. The principle that justifies this form of revenue recognition is called the Percent of Completion Method.

For example, let’s say, on January 15, 2020, the infamous aircraft manufacturer Airbus enters into a $10 billion contract agreement with Emirates Airlines to produce and deliver 100 Airbus A350 aircrafts to the airlines by January 15, 2030. In addition, in the contract, it is stipulated and agreed upon by both parties that Emirates will pay $5 billion of the $10 billion to Airbus on January 15, 2025, when Airbus completes production of the first 50 A350s and delivers them to Emirates, and 50 percent of the contract obligations have been met. Now, let’s fast forward to January 15, 2025. Airbus has met the 50 percent contract obligations and completed production of the first 50 A350s and delivered them to Emirates on time. At this point, Airbus can invoice Emirates the $5 billion for its services up to January 15, 2025 and record sales. Once Emirates pays the $5 billion to Airbus in full amount, the aircraft manufacturer can recognize revenue. At the same time, they can now move forward with the production of the remaining 50 A350 aircrafts.

In summary, revenue recognition is one of the most fundamental principles one will encounter in Accounting. Individuals and business entities are required to recognize revenue for accounting purposes at various points of financial transactions. They can be recognized at the time of sale, when performance obligations are met, and also over a time period during a long-term financial project. Keeping that in mind, we discussed about revenue recognition method after performance obligations are met. Then we discussed about the revenue recognition method over a long period of period when a long-term financial project is ongoing. To make these two key concepts or methods easier for the audience to understand, we elaborated our explanations further by adding on real life examples within our discussions.

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

© 2020 Zunaid Kabir

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://maven.io/company/pages/privacy

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
    ClickscoThis is a data management platform studying reader behavior (Privacy Policy)