Revenue recognition is an accounting principle that dictates when revenue should be recorded in a company's financial statements. The core idea is that revenue is recognized when it is earned, regardless of when the cash is received.
Key Principles:
- Identify the contract with a customer: A contract exists when there's an agreement between two or more parties that creates enforceable rights and obligations.
- Identify the performance obligations in the contract: These are promises to transfer distinct goods or services to the customer.
- Determine the transaction price: This is the amount of consideration the entity expects to be entitled to in exchange for transferring promised goods or services.
- Allocate the transaction price to the performance obligations: If a contract has multiple performance obligations, the transaction price is allocated to each based on its relative standalone selling price.
- Recognize revenue when (or as) the entity satisfies a performance obligation: Revenue is recognized when control of the goods or services is transferred to the customer. This can be at a point in time (e.g., when a product is delivered) or over a period of time (e.g., for subscription services).