The revenue recognition principle states that revenue should be recognized and recorded when it is realized or realizable and when it is earned. In other words, companies shouldn’t wait until revenue is actually collected to record it in their books. Revenue should be recorded when the business has earned the revenue. This is a key concept in the
accrual basis of accounting because revenue can be recorded without actually being received. Revenues are realized or realizable when a company exchanges goods or services for cash or other assets. So if a company enters into a transaction to sell inventory to a customer, the revenue is realizable. A specific amount of cash is identified in the transaction. The revenue is not recorded, however, until it is earned. In this case, the retailer would not earn the revenue until it transfers the
ownership of the inventory to the customer. There are three main exceptions to the revenue recognition principle. Some manufacturers may recognize revenue during the production process. This is common in long-term construction and defense contracts that take years to complete. The revenue in these cases is considered earned at various stages of job completion. Some companies recognize revenue after the manufacturing process but before the sale actually takes place. Mining, oil, and agricultural companies use this system because the goods are marketable and effectively sold as soon as they are mined. The last exception to the revenue recognition principle is companies that recognize revenue when the cash is actually received. This is
a form of cash basis accounting and is most commonly found in installment sales. – Bob’s Billiards, Inc. sells a pool table to bar on December 31 for $5,000. The pool table was not paid for until January 15th and it was not delivered to the bar until January 31. According to the revenue recognition principle, Bob’s should not record the sale in December. Even though the sale was realizable in that the sale for $5,000 was initiated, it was not earned until January when the pool table
was delivered. – Johnson and Waldorf, LLC is an accounting firm that provides tax and consulting work. During December, JW provides $2,000 of consulting work to one of its clients. The client does not pay for the consulting time until the following January. According to the revenue recognition principle, JW should record the revenue in December because the revenue was realized and earned in December even though it was not received until January. – Pat’s Retail, Inc. sells clothing
from its retail outlets. A customer purchases a shirt on June 15th and pays for it on a credit card. Pat’s processes the credit card but does not actually receive the cash until July. The credit card purchase is treated the same as cash because it is a claim to cash, so the revenue should be recorded in June when it was realized and earned.
After reading the Revenue Recognition overview and methodology pages, use what you learned to review the examples below. Unless stated otherwise, the examples assume that revenue recognition takes place on a per-day basis. Stripe’s tooling recognizes revenue every millisecond but using a daily increment simplifies the calculations. Monthly subscriptionThis example uses the following assumptions:
In this example, the invoice and revenue periods are from January 15, 2019 to February 14, 2019. The 31 USD is recognized across 17 days in January and 14 days in February. If you looked at the summary after January ends, you might see something like:
This means that recognized revenue increased by 17 USD for the days in January, and deferred revenue increased by 14 USD for revenue you expect to recognize in February. Annual subscriptionThis example uses the following assumptions:
In this example, the invoice and revenue periods are from 1/1/2019 to 12/31/2019. The 365 USD is recognized daily throughout the year. If you looked at the summary after March ends, you might see something like:
Monthly metered subscriptionThis example uses the following assumptions:
In this example, the invoice and revenue periods are from January 15, 2019 to February 14, 2019. Although the invoice isn’t generated until February 14, the 15 USD from January 25 still has to be recognized when the usage was reported. If you looked at the summary after January ends, you might see something like:
If you looked at the summary after February ends and the invoice is yet to be paid, you might see something like:
UpgradeThis example uses the following assumptions:
If you looked at the summary after May ends, you might see something like:
DowngradeThis example uses the following assumptions:
If you looked at the summary after May ends, you might see something like:
Customer credit balanceThis example uses the following assumptions:
In this example, the invoice and revenue periods are from 1/15/2019 to 2/14/2019. The 31 USD is recognized across 17 days in January and 14 days in February. If you looked at the summary after January ends, you might see something like:
In this scenario, the customer has an existing customer credit balance that’s used to pay the invoice. It’s also possible for a negative amount on an invoice to credit the customer credit balance, which is then used to pay the invoice. This often happens when a customer downgrades to a cheaper subscription. For example, assume that:
The -31 USD line item books a journal entry that debits DeferredRevenue and credits AccountsReceivable. When Stripe credits the customer credit balance, it books another journal entry that debits AccountsReceivable and credits CustomerBalance. In the summary at the end of January, you might see something like:
Notice that eventually the net revenue is -31 USD. RefundThis example uses the following assumptions:
When you make a full refund:
In this example, the customer received one month of service, so they receive a 31 USD refund. The refund also decreases the cash balance in your Stripe account by 90 USD. At the time of the refund, there was 59 USD remaining in deferred revenue, so this is also cleared. If you viewed the summary after March ends, it might look something like this:
Partial refundThis example uses the following assumptions:
When the partial refund is made:
In this example, the customer received one month of service, so 31 USD has been recognized. There is 59 USD remaining in deferred revenue. The partial refund of 9 USD is 10% of 90 USD. Therefore, the refunds account (part of contra revenue) is increased by 3.10 USD (10% of 31 USD), and deferred revenue is decreased by 5.90 USD (10% of 59 USD). If you viewed the summary after March ends, it might look something like this:
VoidThis example uses the following assumptions:
When you void the invoice:
In this example, the customer received one month of service, so 31 USD in recognized revenue is voided. At the time of the invoice being voided, there was 59 USD remaining in deferred revenue, so this is also cleared. If you viewed the summary after March ends, it might look something like this:
UncollectibleThis example uses the following assumptions:
When the invoice is marked as uncollectible:
In this example, the customer received one month of service, so 31 USD in recognized revenue becomes bad debt. At the time of the invoice being marked as uncollectible, there was 59 USD remaining in deferred revenue, so this is also cleared. If you viewed the summary after March ends, it might look something like this:
An uncollectible invoice might still be paid. When the invoice is paid, the bad debt account is cleared out using a part of the received cash amount. The remaining cash amount goes to the recoverables account. If the invoice is paid in April, the summary might look something like this:
An uncollectible invoice may still be voided. When the invoice is voided, the bad debt account is cleared out and the contents are moved into the void account. If the invoice is voided in April, the summary might look something like this:
Uncollectible invoice with applied customer credit balanceThis example uses the following assumptions:
In this example, the invoice and revenue periods are from January 15, 2019 to February 14, 2019. Stripe recognizes the 31 USD across 17 days in January and 14 days in February. Stripe automatically offsets recognized revenue with the bad debt account if an invoice is set as uncollectible. With the customer’s 11 USD credit balance, Stripe considers 6 USD (11 x 17 / 31) as recognized revenue and 5 USD (11 x 14 / 31) as deferred revenue. The portion of paid deferred revenue is considered as a gain and booked in the recoverables account. The summary after February end might look something like:
As another example, you can increase the customer’s invoice due amount when there’s an outstanding balance (that is, they owe some amount to you). Consider the following:
For an uncollectible invoice, the portion of due customer credit balance isn’t collected. Because of this, it is considered a negative gain and booked as a negative amount to the recoverables account. The summary after February end might look something like:
Uncollectible and disputed or refundedAn uncollectible invoice can be paid, then later disputed or refunded. This example uses the following assumptions:
As shown in the Uncollectible example, when the invoice is marked as uncollectible and later paid:
In this example, the customer later decides to dispute the charge. When a dispute occurs, the summary might look something like:
An invoice marked as uncollectible, paid, and later refunded works in a similar manner except that it uses the refunds account instead of the disputes account. DisputeIn case of a dispute, Revenue Recognition works similarly to how a refund works except that it uses the disputes account instead.This example also shows what happens if you win a dispute. It uses the following assumptions:
When the customer makes the dispute:
When you win the dispute:
In this example, the customer received one month of service, so 31 USD in recognized revenue is disputed. The dispute also decreases the cash balance in your Stripe account by 90 USD. At the time of the dispute, there was 59 USD remaining in deferred revenue, so this is also cleared. Later in time, in April, the bank rules in your favor, so the cash is returned to you. If you viewed the summary after April ends, it might look something like this:
Credit note after a paymentYou can use a refund, a customer credit, or an out-of-band credit to issue a credit note to a customer after they’ve made a payment. For example, say a customer starts a subscription for a 3 month period on January 1 at 00:00:00 UTC that costs 90 USD. The subscription generates an invoice and the customer pays it immediately. On February 1, you issue a credit note of 45 USD where you: refund 15 USD; credit 10 USD to the customer balance; and credit 20 USD to an external customer balance (an out-of-band credit). Your summary for March would like something like this:
Credit note without line itemsThis example uses the following assumptions:
When the credit note is issued:
If you viewed the summary after March ends, it might look something like this:
When the credit note is voided on May 3rd:
The summary after June end might look something like:
Be aware that a credit note without line items doesn’t match with a specific invoice line item. Rather, the amount of the credit note is divided proportionally among the invoice line items. Credit note with line itemsA credit note with line items would work in a similar way that a credit note without line items does except that a credit note line item is used for adjusting the revenue and other accounts for a corresponding invoice line item. External assetWhen you manually mark invoices as paid outside of Stripe, the external asset account increases. All other accounts operate as if the invoice is paid, but the cash account doesn’t change. You can import third party transaction data and consolidate all your revenue sources into your Stripe reporting by using the Data Import feature. Below is an example involving the external asset account with the following assumptions:
Tax exemptYour customers can have a tax exemption status of either exempt or reverse. No tax is calculated on the invoice in either case. For example, say a customer with a tax exemption status of reverse starts a monthly subscription on January 1 at 00:00:00 UTC. It costs 31 USD per month and has a tax-inclusive rate of 10%. Because the customer is tax exempt, the total amount due is 27.90 USD. The subscription generates an invoice, the invoice finalizes, and the customer pays the invoice on the same day. Your journal entry would look like this:
Tax-inclusive rate on invoice itemsAn invoice item can include a tax-inclusive rate. When you add an invoice item to an invoice, it can use the same accounting period or a different accounting period from its creation date. Same accounting periodFor example, say a customer starts a service for a period of 1 month on January 1 at 00:00:00 UTC. The total amount due is 34.10 USD and has a tax-inclusive rate of 10%. You add the invoice item to an invoice on January 1, the invoice finalizes, and the customer pays the invoice on the same day. Your journal entry would look like this:
Different accounting periodFor example, say a customer starts a service for a 3 month period on January 1 at 00:00:00 UTC. The total amount due is 100.00 USD and has a tax-inclusive rate of 10%. You add the invoice item to an invoice on March 1, the invoice finalizes, and the customer pays the invoice on the same day. Your journal entry would look like this:
Tax liabilityInvoices and invoice line items can be assigned tax rates. When tax rates are assigned, the Revenue Recognition reports can compute tax liability. Below is an example using an exclusive tax rate with the following assumptions:
Below is an example using an inclusive tax rate with the following assumptions:
Multi-currencyThis example uses the following assumptions:
In this example, you receive 36 USD. Because the invoice finalizes and is paid immediately, you have no exposure to fluctuating exchange rates and therefore no foreign exchange (FX) gains or losses.
FX lossThis example uses the following assumptions:
In this example, the exchange rate changed between invoice finalization and payment, so you receive 33 USD instead of 36.
FX loss from a refund or disputeThis example uses the following assumptions:
In this example, the exchange rate changed between invoice payment and refund, so you receive 36 USD but you later refund 39 USD. Therefore, you incur 3 USD for FxLoss.
A dispute works in the same way as a refund, except that it books the disputes account instead of the refunds account. Multiple settlement currenciesThis example uses the following assumptions:
In this example, you receive 40 USD from the NOK transaction and 30 EUR from the EUR transaction. Because EUR is a supported settlement currency, no exchange rate is applied.
What is meant by revenue recognition?Revenue recognition is a generally accepted accounting principle (GAAP) that identifies the specific conditions in which revenue is recognized and determines how to account for it. Typically, revenue is recognized when a critical event has occurred, and the dollar amount is easily measurable to the company.
What is revenue recognition concept with example?What is the Revenue Recognition Principle? The revenue recognition principle states that you should only record revenue when it has been earned, not when the related cash is collected. For example, a snow plowing service completes the plowing of a company's parking lot for its standard fee of $100.
What are the types of revenue recognition?Common Revenue Recognition Methods. Sales-basis method. Under the sales-basis method, you can recognize revenue at the moment the sale is made. ... . Completed-Contract method. ... . Installment method. ... . Cost-recoverability method. ... . Percentage of completion method.. What is the importance of revenue recognition?But the importance of revenue recognition cannot be overstated: the ability to accurately recognize revenue is vital to a company's financial performance. Top-line recurring revenue needs to be aligned with incurred growth and churn expenses to form the foundation for precise financial reporting.
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