Revenue recognition is an accounting practice whereby income is recognized not when payment has been collected, but when the income is earned. In other words, revenue is recognized when a deal is closed, even before any payment has been made. So if a subscriber signs up for a $36,000 annual subscription, $3000 of revenue is accounted for each month.
With some types of business - particularly subscription businesses which involve an ongoing exchange of services and payment between subscribers and a company - revenue recognition can get complicated. But the importance of revenue recognition cannot be overstated: the ability to accurately recognize revenue is vital to a company's financial performance. Top-line recurring revenue needs to be aligned with incurred growth and churn expenses to form the foundation for precise financial reporting. Once you know the exact financial position of your company, you can better manage operations and make necessary investments in your company.
In order to recognize revenue, the following criteria needs to be fulfilled:
- Persuasive evidence that an arrangement has been made (i.e. a signed contract between vendor and buyer)
- Occurrence of delivery - the vendor must deliver on the contract
- Collectability is probable
- Vendors charges are clear - it helps if the vendor's charges are fixed and on a schedule. Usage-based billing and other variables can complicate fees thus impacting on revenue recognition.
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