Revenue

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What is revenue?

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Revenue is a gross increase owners’ capital or equity, which is resulted by the operations of the business.

Gross increase means that revenue amount is not decreased by any expenses, which were incurred to earn revenue.

The following transactions generate revenue for the business:

• sale of goods
• provision of services
• permission granted to use assets
• sale of assets, like plant assets

Most of revenues have certain features:

• Revenue arises from creating activities of a business
• It creates inflow of funds to the business, consequently increasing equity
• It is measured in the terms of money.
• It is always related to a particular accounting period, in which it is recognized and accounted for
• It is a result of a serious revenue generating activities performed by the business
• Business uses capital to earn a revenue

There are three main revenue recognition methods:

• point of sale, or accrual basis
• cash basis
• installment

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Point of Sale or Accrual Method

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Under this method revenues is recognized, when the ownership title to the goods is transferred from the seller to the customer. Revenue is recorded at the moment of this ownership transfer. Cash can be received later after the ownership title is transferred and this does not impact revenue recognition moment.

The following accounting entries made:

• D Accounts Receivable (debt from the customer)
• _______C Sales Revenue

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Cash Basis Method

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In case cash basis method for revenue recognition is applied, revenue is not recorded, when goods are sold and the ownership title is transferred from the seller to the customer. Basis for the revenue recognition and recording is the moment of cash receipt. Therefore revenue is recognized, when cash is received from the customer for the goods sold/services provided.

It might happened, that first the ownership title to the goods is transferred to the customer (or services are provided), and cash is received later. Sales revenue will be recognized only when cash is received.

The following accounting entries are made:

• D Cash
• _______C Sales Revenue

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Installment Method

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Under the application of this method, revenue is gradually recognized gradually over the period of time

The customer can get a right to use the asset in exchange for the initial payment. Remaining payment is received gradually and revenue is gradually recognized and recorded, applying transaction gross profit percentage.

Let’s explore an example. Let’s assume the business sells equipment:

• Sales price is 750 k$
• Cost is 562.5k $
• Gross profit amount is 187.5 k$
• Gross profit % is 25%

The customer will pay full price of the equipment over 4 years:

• 1^st year  – 150 k$
• 2^nd year – 198 k$
• 3^rd year – 242 k$
• 4^th year – 160 k$

This is a payment schedule agreed between the seller and the customer.

In the table below revenue recognition process is explained

Each year the seller will recognize 25% (gross profit %) of gross profit on the sale, which is calculated on that year payment.

• In the 1^st year it will be 150 k$*25%=37.5 k$
• In the 2^nd year it will be 198 k$*25%=49.5 k$
• And so on

Over 4 year period of time the seller will recognize full amount of gross profit from the sale of equipment

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