What Is Revenue Recognition?
Throughout the sales process, there are many different points when your business could recognise revenue. Thats what the revenue recognition principle  which has become increasingly crucial after IFRS 15 and ASC 606  can help you to understand. Explore all that, and more, with our guide to revenue recognition. Understanding the revenue recognition principle  In a nutshell, revenue recognition is an accounting principle that cash doesnt become revenue until youve delivered the product/service. This is because up until that point, the customer can ask for a refund. If youve already spent the money, thats a big problem, and it can lead to significant issues with your companys accounts. As such, its vitally important to pay attention to revenue recognition. When a product is sold, paid for, and delivered in short order  as with e-commerce companies  revenue recognition isnt such a big deal. However, revenue recognition can get much more complicated if youre running a subscription business. Think about it. Even if your customers pay upfront for an annual subscription, you cant mark the payment as revenue because you havent delivered the service in full. Lets find out. Until relatively recently, there hasnt been a standardised revenue recognition process. The introduction of IFRS 15 and ASC 606 has changed all that, providing businesses with a consistent framework for reporting revenue. Although these compliance standards can be a little complicated, they boil down to five basic steps, which are as follows:  Identify the contract with the customer  Firstly, you need to ensure that the agreement, or contract, that you have with your customer spells out what goods/services youve agreed to deliver, as well as the payment terms for those goods/services. Determine the performance obligations of the contract  Next, you need to confirm all the obligations stipulated in the contract. Usually, this refers to the provision of specific goods/services, but it can also cover discounts, bonuses, credit, etc. Identify the total transaction price  Now, youll need to ensure that the contract states very clearly how much the customer will be charged for the goods/services youre providing. Match the performance obligations to the transaction price  Then, youll need to break down the cost of each good or service that youre delivering. SaaS businesses have a continuous performance obligation, so youll need to allocate a share of the total transaction price to each month or billing period. Recognise revenue upon delivery  The final piece of the puzzle is to make sure that youre recognising revenue only after the fulfilment of each performance obligation. There are five essential criteria: the risks and rewards have been transferred to the seller, the seller has no control over the goods being sold, the collection of payment has been assured, the amount of revenue can be measured, and the cost of earning that revenue can be measured. At this point, the ASC 606 revenue recognition conditions have been met, and you can count your billings as revenue. The revenue recognition principle has several important benefits. Firstly, it provides you with real-time insight into your companys profit and loss margin. This means that youre always getting the most accurate reading on your businesss financial health. By ensuring the credibility of your accounting records, you can continue making financially-sound decisions, maintaining a steady balance of revenue and expenses. Since financial stability is a significant factor for investors, the revenue recognition principle may also be relevant for companies seeking financing. We can help  GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.