What is Revenue Recognition?

Revenue recognition is the conditions under which an organization can recognize a sale transaction as revenue. The intent of revenue recognition is to do so in a manner that reasonably depicts the provision of services to customers, for which consideration is paid that reflects the amount to which the seller expects to be entitled. This is a key area of accounting, since business owners routinely attempt to accelerate the recognition of revenue in order to show better corporate performance than is really the case.

How to Recognize Revenue for Services

When a business is selling services to its customers, it should use one of the following methods to recognize the resulting revenue. The method selected should be based on the type of services performed, as noted below.

Collection Method

When there is considerable uncertainty regarding whether the service provider will be paid, use the collection method. This approach mandates that you do not recognize any revenue until cash payment is received from the customer. This is the most conservative revenue recognition method.

Completed Performance Method

In situations where a series of services are performed, but completion of the contract hinges on a specific activity, use the completed performance method. Under this method, do not recognize any revenue until the entire set of services have been completed. For example, a moving company is hired to box up, transport, and redeploy the assets of a company; although there are several services provided, redeployment is the key part of the contracted services, so it may not be appropriate to recognize revenue until this task has been completed.

Specific Performance Method

When the customer pays for the completion of a single specific activity, recognize revenue when that activity has been completed. For example, a doctor is paid for a specific office visit. This is the most common type of revenue recognition used for services.

Proportional Performance Method

When a number of similar activities are completed as part of a service contract, use the proportional performance method to recognize revenue. There are two ways to use this method. First, if each of the services provided are essentially identical, then recognize revenue proportionally across the estimated number of service events. Second, if each of the services provided is different, then recognize revenue based on the proportion of costs expended.