What is Revenue Realization?
Sellers sometimes recognize only after the sale that they will never realize revenues.
For companies that use accrual accounting, revenues from sales of goods and services are said to be realizable revenues by the seller only when there is a good reason to believe the seller will receive payment.
When the customer does pay, or when the buyer provides proof that payment is truly forthcoming, the seller realizes revenues.
By contrast, for companies that use cash basis accounting, the realization concept does not apply. Under cash basis accounting, sellers claim sales revenues only when customers pay in cash.
Explaining Revenue Realization in Context
Sections below further define and explain realization in context with related accounting terms, emphasizing three themes:
- First, the reason that sales revenues must be realizable, in order to claim as earned revenues.
- Second, the role of revenue realization in accrual accounting transactions.
- Third, steps sellers must take when sales revenues are unrealizable.
Contents
Realized and Realizable Revenue
When Does Accrual Accounting Recognize Revenues?
Under accrual accounting realizability is one of the two conditions that must exist before the seller can claim incoming sales revenues. The revenue claim impacts two accounts: Firstly, an Income statement Revenue account such as "Sales revenues" and secondly, a Balance sheet Assets account such as "accounts receivable." Sellers can claim revenues for these accounts by meeting these two conditions:
- They believe they will realize (collect) these revenues.
- The seller earns the revenues by delivering goods or services.
Until the seller meets both conditions, sellers carry the revenues in a Liability account such as Unearned Revenues.
Realizing Revenues Before Earning Revenues
Consider, for instance, a computer user buying a one-year subscription to an online backup service. Computer users normally pay for these subscriptions in advance. When the customer submits an advance payment transaction, the service provider realizes revenues, immediately.
Nevertheless, the seller also classifies the same revenues initially as Unearned Revenues, an entry in a Liability account. As the customer uses the service, month by month, the seller will transfer funds from the Liability account to the Revenue account Sales Revenues.
See the following article for more on the bookkeeping transactions and accounting reporting of unearned and unrealized revenues.
