SAP ERP Financials and FICO Handbook

7.5 REVENUE RECOGNITION 273
7.5 REVENUE RECOGNITION
The revenue recognition principle arises from accrual accounting and the
matching principle. Accrual accounting and the matching principle help the user
determine how a business entity will determine whether a particular transaction
will be treated as an expense or revenue.
In accrual accounting, revenues are recognized when you have realized and
you have performed, i.e., when goods are transferred or services rendered, no
matter when cash is received.
In cash accounting, revenues are recognized when you have received cash,
regardless of the timing of goods or services sold. Revenue recognition depends
upon the nature of the transaction. From an academic point of view, transactions
can be broadly divided into four types: (1) selling inventory, (2) selling services,
(3) leasing activities, and (4) selling of assets other than inventory.
Revenue recognition occurs from four types of transactions:
1. Revenue from selling inventory is recognized at the date of sale, which is
often interpreted as the date of delivery.
2. Revenue from rendering services is recognized when services are completed
and billed.
3. Revenue from permission to use a company’s assets (e.g., interest for using
money, rent for using fixed assets, and royalties for using intangible assets)
is recognized as time passes or as assets are used.
4. Revenue from selling an asset other than inventory is recognized at the point
of sale when it takes place.
Revenue recognition mostly applies when you are billing your customer in
advance. For example, you entered a service contract (such as a maintenance
contract) with your customer for $12,000 for one year. As per payment terms,
you billed your customer in advance. Therefore, as of January 1, you billed your
customer for an entire year and the customer paid. At the end of January, you can
treat $1,000 as your income and the remaining $11,000 remains as a liability.