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9.1 Explain the Revenue Recognition Principle and How It Relates to Current and Future Sales and Purchase Transactions

Revenue Recognition Principle​

The revenue recognition principle states that revenue should be recognized (recorded) when it is earned, regardless of when cash is received.

Key Concept: Revenue is earned when goods are delivered or services are performed, not necessarily when payment is received.

When is Revenue Earned?​

For Sales of Goods:

  • Revenue is earned when goods are delivered to the customer
  • Ownership transfers to customer
  • Customer has obligation to pay

For Services:

  • Revenue is earned when services are performed
  • Service is complete or substantially complete
  • Customer has obligation to pay

For Long-Term Projects:

  • Revenue can be recognized over time (percentage of completion)
  • Or at completion (completed contract method)

Revenue Recognition and Receivables​

Credit Sales:

  • Revenue is recognized when sale is made (goods delivered or service performed)
  • Accounts Receivable is created (asset)
  • Cash is received later

Example:

  • Business sells €1,000 of goods on credit on November 15
  • Revenue recognized: November 15 (€1,000)
  • Accounts Receivable created: November 15 (€1,000)
  • Cash received: December 10 (€1,000)

Journal Entry (Sale):

410000 Accounts Receivable        €1,000
700000 Sales Revenue                          €1,000
To record credit sale

Journal Entry (Collection):

510000 Cash                        €1,000
410000 Accounts Receivable                    €1,000
To record collection of receivable

Cash Sales vs. Credit Sales​

Cash Sales:

  • Revenue recognized when cash is received
  • No receivable created
  • Immediate cash flow

Credit Sales:

  • Revenue recognized when sale is made
  • Receivable created
  • Cash received later

Both follow revenue recognition principle: Revenue is recognized when earned (sale made), not when cash received.

Future Sales and Purchase Transactions​

Future Sales (Unearned Revenue):

  • Cash received before revenue is earned
  • Recorded as liability (Unearned Revenue)
  • Revenue recognized when earned

Example:

  • Customer pays €500 in advance for services
  • Cash received: November 1
  • Services performed: December 15

Journal Entry (Cash Received):

510000 Cash                        €500
470000 Unearned Revenue                        €500
To record advance payment

Journal Entry (Revenue Recognized):

470000 Unearned Revenue           €500
700000 Service Revenue                        €500
To recognize revenue when services performed

Future Purchases (Prepaid Expenses):

  • Cash paid before expense is incurred
  • Recorded as asset (Prepaid Expense)
  • Expense recognized when incurred

Example:

  • Business pays €1,200 for annual insurance
  • Cash paid: January 1
  • Expense recognized monthly: €100 per month

Journal Entry (Cash Paid):

460000 Prepaid Insurance          €1,200
510000 Cash                                    €1,200
To record prepaid insurance

Journal Entry (Expense Recognized):

613000 Insurance Expense          €100
460000 Prepaid Insurance                      €100
To recognize insurance expense for the month

Luxembourg VAT Considerations​

VAT on Credit Sales:

  • VAT is due when sale is made (revenue recognized)
  • Not when cash is received
  • VAT Payable created at time of sale

Example:

  • Credit sale: €1,000 (excluding VAT), VAT 17%
  • Revenue: €1,000
  • VAT Payable: €170
  • Accounts Receivable: €1,170

Journal Entry:

410000 Accounts Receivable        €1,170
700000 Sales Revenue                          €1,000
430000 VAT Payable                              €170
To record credit sale with VAT

VAT on Uncollectible Accounts:

  • If account becomes uncollectible, VAT may be recoverable
  • Must follow Luxembourg VAT rules
  • Proper documentation required

Luxembourg Compliance Note​

Revenue recognition in Luxembourg must:

  • Follow accounting standards
  • Comply with PCN requirements
  • Recognize VAT at time of sale
  • Properly classify receivables (Class 4)
  • Maintain proper documentation
  • Support tax reporting

Think It Through​

Why is it important to recognize revenue when it's earned rather than when cash is received? How does this affect accounts receivable?