When are revenues earned?
/When revenue is earned will depend on whether you use the accrual basis of accounting or the cash basis. Under the accrual basis, revenue is recorded when it is earned, while revenue is recorded under the cash basis when the associated cash is received from the customer. This is a relatively simple matter under the cash basis, since it is dependent on just one event - the receipt of cash. The situation is more complex when you are using the accrual basis; under this approach, the general concept is that revenues are earned when goods or services are transferred to the customer. This transference is considered to occur when the customer gains control over the good or service. Indicators of this date include the following:
When the seller has the right to receive payment.
When the customer has legal title to the transferred asset. This can still be the case even when the seller retains title to protect it against the customer’s failure to pay.
When physical possession of the asset has been transferred by the seller.
When the customer has taken on the significant risks and rewards of ownership related to the asset transferred by the seller. For example, the customer can now sell, pledge, or exchange the asset.
When the customer accepts the asset.
When the customer can prevent other entities from using or obtaining benefits from the asset.
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Example of When Revenue is Earned
A widget manufacturer accepts a prepaid order for 1,000 green widgets from an overseas customer. The manufacturer produces the widgets a month later and ships them to the customer by air freight. Title to the widgets passes upon receipt of the goods. In this case, revenues are earned when the customer receives the widgets.
Revenue Recognition for Extended Performance Obligations
It is possible that a performance obligation will be transferred over time, rather than as of a specific point in time. If so, revenue recognition occurs when any one of the following criteria are met:
Immediate use. The customer both receives and consumes the benefit provided by the seller as performance occurs. This situation arises if another entity would not need to re-perform work completed to date if the other entity were to take over the remaining performance obligation. Routine and recurring services typically fall into this classification.
Immediate enhancement. The seller creates or enhances an asset controlled by the customer as performance occurs. This asset can be tangible or intangible.
No alternative use. The seller’s performance does not create an asset for which there is an alternative use to the seller (such as selling it to a different customer). In addition, the contract gives the seller an enforceable right to payment for the performance that has been completed to date. A lack of alternative use happens when a contract restricts the seller from directing the asset to another use, or when there are practical limitations on doing so, such as the incurrence of significant economic losses to direct the asset elsewhere.