To stay afloat, attract new business, and avoid trouble, your company must provide clients, investors, and government agencies with accurate revenue statistics. But did you know there are several different legal ways to recognize and record revenue?
Which method you choose is a decision best left to you and your financial staff, including your CPA, CFO, or accountant. Together, you can decide which revenue recognition methods best fit your needs, industry, and business setup.
Choosing a Revenue Recognition Strategy
Anyone running a business should be familiar with the revenue recognition strategies available. Armed with the right information, you’ll be able to have a meaningful discussion with your staff and stakeholders. Most importantly, you can use that information to make an informed decision when choosing how to recognize your business revenue.
The methods for recognizing revenue include:
- The sales-basis method recognizes revenue at the time a sale is made. Whether the transaction is made using cash or credit doesn’t matter. The revenue is recognized the moment goods or services are transferred to the possession of a buyer or client. Sales-basis revenue recognition is generally the most accurate way to record revenue.
- Under the completed-contract method, revenue and expenses are only recognized when a contract comes to an end, signaling the completion of work. The completed-contract method must be used in the absence of a long-term, enforceable contract, and/or when calculating the percentage of completion of said contract is not possible.
- Percentage-of-completion means that revenue may be estimated based on how complete the project or contract is. This method works well for long-term contracts like construction or software development. This method is beneficial for companies who want to show incoming revenue even though there may be incomplete projects underway. This method is usually used with long-term contracts that are subject to legal enforcement, where estimating the percentage of completion is not inherently difficult.
- The cost-recoverability method doesn’t allow revenue to be recorded until all necessary expenses for completing the project have been recouped. In other words, nothing can appear as profit until the total cost of obtaining it has been made up. This method may understate profits initially, but overstate revenue in coming years.
- An installment revenue recognition strategy may be used if collecting payments from customers is unreliable. This method is often used in real estate, where a sale price is agreed to, but cannot be collected until or unless the buyer obtains financing. Once payments begin, revenue is recognized on an installment basis over the term of the contract.
How complicated revenue recognition may become depends on your industry and how your business is structured. There are many nuances that are subject to rigorous regulation. Therefore, it’s imperative to get professional counsel in revenue recognition. When it comes to stating income, you can never be too careful.