According to the revenue recognition principle, income must be recorded when it is generated rather than when it is received. This implies that even if the money is not received until a later period, income should be recorded in the period in which the sale is made. For instance, if a business offers a product on credit, the revenue should be recorded when the product is delivered rather than when the consumer makes the payment.
There are a few different ways that companies can recognize revenue, but the most common is the accrual method. When income is produced through this way, regardless of when payment is actually received, the company records it. The cash approach, in contrast, only records income when the cash is received.
Accrual technique is generally considered to be more accurate, because it matches revenue with the expenses incurred in earning that revenue. For example, if a company sells a product on credit, the cost of goods sold (COGS) is mention when product is sold, not when buyer pays for it. This prevents the income statement from being artificially inflated in periods when cash is received, and artificially deflated in periods when cash is not received.
There are a few exceptions to the revenue recognition principle, such as for certain types of contracts (such as construction contracts) and for certain types of businesses (such as insurance companies). In general, though, the revenue recognition principle should be followed in order to produce accurate financial statements.
The revenue recognition principle is an important part of accrual accounting that is used by organizations. Revenue is recorded when it is earned, not when it is received, according to accrual accounting. This means that even if the money is not received until a later period, firms must report income when it is earned.