Revenue Recognition

When should you log incoming revenue: when the cash comes in or when you deliver the service?

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Back a hundred years ago when I had a catering company, I used to take deposits from my clients for events. Sometimes the deposits would come in March, even though the party wasn’t going to be until May. But I never recognized that revenue in March. Even though I got the money then, I didn’t want to put it on my income statement as revenue. Now, to be fair, I would actually go and deposit the check into the bank account. And I did that for a couple of reasons. One, I just wanted to make sure that the check cleared. And two, I was going to have costs associated with the event that I was going to need to pay for. So I wanted to make sure I had the cash available. But I didn’t mark it as revenue; I marked it as unearned revenue, which was actually a liability account.

Now, the reason why I did that as a liability account as opposed to revenue was that I wanted to be able to look at May when the party happened and know what I actually earned. I wanted to know what my revenue was, and what my expenses were, associated with the party. If I had the revenue marked in March, when I took the deposit check, everything would be askew, and the revenue from March would be high, and expenses for May would be low–or those would be high. And things wouldn’t really correlate. Also, in subsequent years, when I wanted to look back and say “hey, how did I do in May?” I wouldn’t be able to see how I really did in May because the revenue was recognized in March when I got the check, and not in May when I did the event.

The point of my whole story is that it’s really important to recognize revenue not necessarily when the money in comes in, but when the service or the goods are provided. It’s going to help you keep cleaner books, and better understand how the cycle of your business works. Revenue recognition ties in really nicely with the matching principle. If you think back to the example of my catering company, and I recognize the revenue in May, I also had all the associated expenses of that party in May. So I wanted to match the revenue and the expenses in the same period so I could really see how my business is doing. If for example the invoices for some of the food I purchased didn’t show up until June, I would still want to have the expenses match with the revenue in May so I could really see the effects of the expenses and how that impacted my revenue in terms of my net income.

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