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The revenue recognition principle is a critical component in accrual accounting along with the matching principle. Both of these principles are useful in determining the accounting period in which expenses and revenues are acknowledged. Based on the revenue recognition principle, revenues are acknowledged at the time they are realized and earned regardless of the time when the payment is made. In contrast, in cash accounting, revenues are recognized at the time cash is received without regard to the time of selling the goods.
Under the general rule, received advances are not viewed as revenues. Instead, they are recognized as liabilities or deferred income. However, this position holds after the following two conditions are met. Under the first condition, revenues are realizable when either cash or claims to cash are obtained when exchanging goods or services. Revenues are realized when the assets that are received in such exchanges are convertible to either cash or claims to cash. The second condition relates to revenues that are earned when goods or services are rendered. Both payment and confirmation of such are required.
According to Kimmel, Weygandt and Kieso (2011), revenue recognition arises from four types of transactions. First, revenue is gained from the sale of inventory, which is recognized at the time of sale or delivery. Secondly, revenue that is available after rendering services that are recognized as completed and billed services. In the third place, it is revenue that is realized out of extension of permission to use assets of a company. Finally, reference is made to revenue raised through the sale of inventory at the point of sale. Based on this synopsis, revenue is recognized upon the sending of an invoice. By playing a role in the determination of the accounting period in which expenses and revenues are acknowledged, the revenue recognition principle proves to be an important element in accounts.