Understanding Revenue Recognition and Realisation in accounting

Revenue Recognition and Realisation in accounting represent the profits companies and individuals make from selling assets. However, there are certain difference between Revenue Recognition and Realisation.

Revenue recognition is an aspect of accrual accounting that stipulates when and how businesses “recognise” or record their revenue. The principle requires that businesses recognise revenue when it’s earned (accrual accounting) rather than when payment is received (cash accounting). Hence, the value of the recognised gain a company earns from selling an asset is its revenue rather than total profit. 

Unrealised gain: An unrealised gain occurs when the market value of an asset is higher than its purchase price, but the asset has not been sold. It’s also known as a “paper” gain because it’s only an accounting entry until it’s realised.

Realised gain: In financial accounting, the gain is unrealized until the asset is sold for cash, at which point it becomes a realised gain. In other words, for a company to realise profits from an asset they have made, it must receive cash and not simply witness the market price of its asset increase without selling. Thus, realised gains account for costs and expenses and show the total profits of a company from the sale of an asset. Only the realised gain, not the unrealised gain is computed for income tax assessment.

Indian Accounting Standard (Ind AS) 18 and Ind AS 115 provide guidelines for recognizing revenue in different situations:

Indian Accounting Standard (Ind AS) 18 applies to revenue from the sale of goods, services, and the use of assets that generate interest, royalties, or dividends. Revenue is recognized when it’s probable that the entity will receive economic benefits from the transaction and can reliably measure those benefits. For example, if a company can reliably estimate future returns and account for returns based on experience, revenue is recognized at the time of sale.

Ind AS 115 standard applies to revenue from contracts. Revenue is recognized when the entity can reasonably measure the outcome of the performance obligation. The transaction price is the amount of consideration the entity expects to receive in exchange for transferring goods or services.

Ind AS 115 has been amended to provide that penalties are required to be accounted for as per the substance of the contract. Where the penalty is inherent in the determination of transaction price, it would form part of variable consideration; otherwise the same would not be considered for determining the consideration.

Here are some other things to consider when recognizing revenue:

Matching: The matching principle in accounting requires that expenses be recorded in the same period as the revenues they help generate. This ensures that the profit reported for a period is accurate.

Ongoing services: If an agreement calls for an ongoing service, the revenue recognition period is usually determined by the agreement. If the agreement doesn’t specify a period, revenue is recognized over the useful life of the asset used to provide the service.

Uncertainties: When there’s uncertainty about the collectability of revenue already included, the uncollectible amount is recognized as an expense.

Disclosure: Enterprises should disclose when revenue recognition is postponed due to significant uncertainties.

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