Accountancy · Ch 2 — Theory Base of Accounting
Revenue Recognition (Realisation) Concept
Revenue Recognition (Realisation) Concept
Revenue Recognition (Realisation) Concept
This concept answers two fundamental questions: what counts as revenue, and when should that revenue be recorded in the books.
Revenue is the gross inflow of cash arising from two sources:
- The sale of goods and services by the enterprise
- The use by others of the enterprise's resources, yielding interest, royalties, and dividends
The critical rule is that revenue is recognised only when it is realised — meaning a legal right to receive it has arisen. This happens at the point when goods have been sold or services have been rendered, regardless of whether cash has actually been received.
Credit sales are treated as revenue on the day the sale is made, not when money is collected from the buyer. The journal entry for a credit sale is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Debtor's A/c Dr. | xxx | |||
| To Sales A/c | xxx | |||
| (Being goods sold on credit) |
The debit to Debtor's Account recognises the legal right to receive payment. The credit to Sales Account records the revenue at the moment of sale.
For incomes such as rent, commission, and interest, recognition is done on a time basis. The revenue belongs to the period in which it is earned, not the period in which cash changes hands.
Rent for March 2017, even if received in April 2017, is taken into the Profit and Loss Account of the financial year ending 31 March 2017 — not the year beginning April 2017.
Similarly, if interest for April 2017 is received in advance in March 2017, it belongs to the financial year ending March 2018 and is recorded in that year's Profit and Loss Account.
Exceptions to the General Rule
There are two important exceptions where the standard recognition rule is modified:
Long-term contracts — In cases like construction work that takes 2–3 years to complete, revenue is not deferred until the entire project finishes. Instead, a proportionate amount of revenue, based on the part of the contract completed by the end of the accounting period, is treated as realised. This is known as the percentage-of-completion method. …