Posted by Jess on .
The revenue recognition principle simply dictates that revenue is recognized in the accounting period that it is earned. For human service organizations, revenue is considered to be earned at the time a service is delivered. For example, let's say a physician sees 25 people on June 30th, but does not receive payment for those services until the first week in July. Under the revenue recognition principle, the revenue is considered earned in June when the service was rendered, not in July when the revenue was received. Improper application of this principle can have some serious consequences.
What is the potential impact on a business when this rule is not followed? How does this relate to the accrual or cash-basis of accounting?
Some of the implications of not following this rule are that on one hand, by recognizing cash before you earn it, i.e. the doctor listing cash BEFORE he sees clients, the balance sheet would now show cash on hand that the company really hasn't earned. Should a patient cancel an appointment, then the doctor really wouldn't have that cash. Someone in the meantime may look at the cash account and spend the money that hasn't technically been earned yet.
On the other hand, should you record the revenue late, it could impact the business' ability to make a purchase in the time period in which the revenue was earned.