Revenue recognition is the accounting principle that says you record revenue when it’s earned, when goods or services are delivered, not when the cash arrives. This guide explains the ASC 606 five-step process, why it matters, worked examples from a car sale to a construction project, and how NetSuite automates it.
Revenue recognition refers to the specific accounting period in which you record the revenue earned from a transaction. Accounting standards dictate that revenue should be recognized when it is earned , not when the cash is collected. This means revenue is earned when you deliver goods or services to the customer, not when they pay for them.
How to Recognize Revenue
The new accounting rule, ASC 606, outlines a five-step process for recognizing revenue from contracts. This applies to situations where goods or services are delivered over a period of time. Here are the five steps:
- Identify the contract with the customer.
- Identify performance obligations.
- Determine the transaction price.
- Allocate the transaction price to performance obligations.
- Recognize revenue as the performance obligations are met.
Why Revenue Recognition Matters
Following accounting standards is crucial for maintaining the integrity of your financial reports. These reports are essential for various purposes, such as selling a division of your company, securing a bank loan, or attracting investors. Accurate financial reports are key to building trust and confidence with these stakeholders.
Example of Revenue Recognition
Let’s start with an easy example – a sports car.
You sell the car in September for $350,000 and Mr. Smith pays cash for it. This is easy, the $350,000 revenue is recognized in September.
You sell the car in November for $350,000 and Miss Lewis pays for the car over 60 months in installments. You record the $350,000 revenue in November.
Now for a more complicated example – a magazine subscription.
You sell Martha a 2 year magazine subscription to Car and Driver magazine for $240 in July and collect $240 in July. This is a 2 year contract with the magazine delivered monthly. 2 years = 24 months. You recognize $24 dollars a month for each of 24 months.
Finally, the most complicated example – Construction. In this last example, you are building a swimming pool for a customer.
You are building a swimming pool for the Jefferson family for $50,000. You collect $50,000 up front. This would be recorded as a deposit to be applied to revenue as it is earned. Revenue is earned as key steps in the process are completed.
| Performance Obligation | Revenue to Recognize |
|---|---|
| Design completion | 10% or $5,000 |
| Excavation completion | 20% or $10,000 |
| Plaster completion | 30% or $15,000 |
| Equipment installation | 30% or $15,000 |
| Final Inspection | 10% or $5,000 |
Tips and Tricks for Revenue Recognition
For contract sales, revenue recognition can be a complex process. Accounting software like NetSuite offers modules to simplify and ensure proper revenue recording, eliminating the need for manual journal entries and external spreadsheets within your ERP system.
Why Revenue Recognition and NetSuite?
Revenue recognition rules have been put in place to standardize financial reporting for contracts. NetSuite automates and simplifies the revenue recognition process, ensuring compliance with US and international standards. Whether your business deals with products, services, or a combination of both, across single or multiple milestones, NetSuite provides a rule-based event handling framework. This meticulously schedules, calculates, and presents your revenue, not only enhancing the accuracy of your financial statements but also optimizing revenue forecasting, allocation, recognition, reclassification, and auditing.
If you’re looking to unlock the full potential of NetSuite saved searches, we can help. Our NetSuite consulting experts can provide guidance, training, and support tailored to your specific needs. Contact us today to learn how we can elevate your NetSuite experience.
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