The principles of revenue recognition accounting are necessary for corporations to accurately describe their financial standing. Identifying when a company has earned income is not necessarily simple with many factors to take into consideration. Working out exactly when earnings can be attributed as income is subject to application of rules and good judgement.
To establish whether a corporation is entitled to claim revenue, there are four tests to consider. Customers must have agreed to buy from the supplier. There must be an agreed price for the goods or services. The goods or services must have been delivered or completed by the supplier. And the supplier must be satisfied that the customer can pay the bill, and is required to make full payment.
A company not getting the timing of income recognition right can do itself immense damage. Recognizing earnings too soon can lead to additional tax to pay and overstated yields that can mislead shareholders and investors. This usually comes about through incorrect income splits or assessment of what completes the transaction, and creates the subsequent liability for the client to pay. Accountants work hard to ensure the timing of revenues is done accurately, and fairly.
Working out when the goods have been delivered or services performed is not always simple. It is easy to determine if a valid contract has been agreed, if price has been agreed and that the bill can be paid. Getting the work completed, the product in the hands of the customer, and ensuring what has been promised is delivered is the hard part.
The normal expectancy is that both the supplier and customer will record the transaction in the same accounting period. When this does not happen, then the question of revenue allocation needs to be looked at. Examples of this is paying insurance annually in advance, or shipping goods out overnight on the last day of the month.
For example, an insurance agent gets paid full commission on the initial signing of a contract with the customer, but is subject to pay back of commissions if the customer cancels the policy inside of two years. While the agent has been paid, the value of the sale is dependent on a future event, namely that the customer pays premiums for two years. There is a case to argue that income, or some of the income, has not been earned until the future event has been fulfilled.
Another situation occurs in construction where long term projects are common. Progress claims are submitted by contractors to clients and these are agreed on for part of the works done and paid. When a progress claim is paid, then that part of the contract is determined to have been complete and the customer taken ownership, even thought he full job is not complete. The rule of thumb on this is could another person or company take over a partially finished job and complete the works. Because the answer is yes, income can be recognized during the works.
Allocating revenue to the right accounting period is an important principle. This enables financial information to accurately describe what is happening with the business. Often, external audit firms are employed to confirm the correct revenue recognition accounting principles are followed. Adhering these rules helps shareholders, employees and lenders keep faith in the company.
To establish whether a corporation is entitled to claim revenue, there are four tests to consider. Customers must have agreed to buy from the supplier. There must be an agreed price for the goods or services. The goods or services must have been delivered or completed by the supplier. And the supplier must be satisfied that the customer can pay the bill, and is required to make full payment.
A company not getting the timing of income recognition right can do itself immense damage. Recognizing earnings too soon can lead to additional tax to pay and overstated yields that can mislead shareholders and investors. This usually comes about through incorrect income splits or assessment of what completes the transaction, and creates the subsequent liability for the client to pay. Accountants work hard to ensure the timing of revenues is done accurately, and fairly.
Working out when the goods have been delivered or services performed is not always simple. It is easy to determine if a valid contract has been agreed, if price has been agreed and that the bill can be paid. Getting the work completed, the product in the hands of the customer, and ensuring what has been promised is delivered is the hard part.
The normal expectancy is that both the supplier and customer will record the transaction in the same accounting period. When this does not happen, then the question of revenue allocation needs to be looked at. Examples of this is paying insurance annually in advance, or shipping goods out overnight on the last day of the month.
For example, an insurance agent gets paid full commission on the initial signing of a contract with the customer, but is subject to pay back of commissions if the customer cancels the policy inside of two years. While the agent has been paid, the value of the sale is dependent on a future event, namely that the customer pays premiums for two years. There is a case to argue that income, or some of the income, has not been earned until the future event has been fulfilled.
Another situation occurs in construction where long term projects are common. Progress claims are submitted by contractors to clients and these are agreed on for part of the works done and paid. When a progress claim is paid, then that part of the contract is determined to have been complete and the customer taken ownership, even thought he full job is not complete. The rule of thumb on this is could another person or company take over a partially finished job and complete the works. Because the answer is yes, income can be recognized during the works.
Allocating revenue to the right accounting period is an important principle. This enables financial information to accurately describe what is happening with the business. Often, external audit firms are employed to confirm the correct revenue recognition accounting principles are followed. Adhering these rules helps shareholders, employees and lenders keep faith in the company.
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