Realization Concept (Revenue Recognition)

'Revenue is the gross inflow of cash, receivables or other consideration arising from the sale of goods, from rendering services and from holding assets'. Recognizing this revenue (the stage or time) becomes critical for determining the income of an entity. For example, sale of goods involves many stages such as acceptance of order, the stage of commencement of the work for the specified order, delivery of goods after completion of the work, invoicing, actual receipt of the money. At which time would one say that revenue is recognized? The realization concept smoothens the ambiguity on this front. Revenue is to be recognized when the sale actually takes place i.e., the title to the goods is transferred and accepted by the buyer and there exists a reasonable certainty of receiving a return consideration in the future. Revenue for service transactions is generally recognized on performance of service.

However, there are certain exceptions:

Revenue recognition at work-in-progress stage: In the case of long-term construction contracts, etc., the contractor may elect to follow the percentage of completion method or the completed contract method. Under the percentage of completion method, revenue is recognized as the contract activity progresses based on the stage of completion reached. In case of completed contract method, revenue is recognized only when the contract is completed or substantially completed.

Revenue recognition on production: Similarly, when a firm manufactures a product which has an assured market, there is a reasonable certainty that the product would take off as soon as it is produced. Thus, the revenue may be recognized on production.

Revenue recognition on cash basis: Where there is doubt or risk of collection of the amount, revenue recognition is postponed to the stage of its actual realization. For example, the revenue is recognized by doctors, lawyers and other professionals in their books of accounts when the amount is actually collected.