Revenue Recognition

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REVENUE RECOGNITION

The accountant determines income by subtracting expenses from revenues. As simple as this may seem, there are many complexities that arise when trying to implement this concept. For example, there are many activities and events that must take place to generate revenues. The accountant adopts the procedure of recognizing revenues at the time a certain critical event takes place. But which event is important enough to justify the recognition of revenue? Depending on the situation, there are several acceptable methods of revenue recognition; some of them are listed below.

Production Basis. Production is the critical event for companies that produce or construct assets under long-term production or construction contracts. For Example, Boeing Aerospace did not build the Boeing 747 and 767 aircrafts to open stock. Instead, these aircrafts are built to customer specifications under production contracts. These contracts specify who the customer is and the amounts and timings of cash flow. As a result, the contracts reduce the uncertainty of the sale and cash receipts events. Companies that produce to order under production or construction contracts often attempt to spread prospective revenues, related costs, and resulting net income over the life of the contract in proportion to the work accomplished. The method used to accomplish this spreading of revenues, costs, and income is called the percentage of- completion or production method.

Sales Basis. The sales (or accrual) basis is the most widely used method for recognizing revenues. Revenues are assumed to be earned at the time the sale is made, even though the cash may not have been collected from customers. For companies that produce to open stock, the sale is the critical event for revenue recognition. Even though value is added to goods through the production process, these companies face considerable uncertainty about who the customer will be and about the amount and timing of the...
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