Revenue recognition principle can be seen as a justification of accrual-based accounting, in line with matching principle to show that companies are able to record revenues and expenses in the respective financial year when they are actually incurred.
This has an accounting implication in the sense that it requires companies to record their revenues when they have actually earned it, as opposed to when they receive the payment or the compensation for it.
Subsequently, it requires companies to be able to record their revenue, and their expenses when they have actually incurred it.
As a result of this, recording revenue has to be considered in that aspect, so that revenues and expenses can be matched across a given time period only.
Revenue can simply be defined as the amount that is obtained by the companies in exchange for the goods and services that they provide.
Depending on the main operations of the company, this amount can vary from situation to situation, and hence, companies are likely to choose their approach towards recording revenue in accordance with how they collect this particular amount. Revenue can broadly be categorized into two types, earned revenue and unearned revenue.
As far as earned revenue is concerned, this is the amount that is generated against the sale of goods and services, which have already been provided to the buyer.
Therefore, it is a straightforward process, which requires recording these transactions in exchange for the goods and services that have already been provided for. The journal entry that is used to record revenue (earned) is as follows:
Debit – Cash / Accounts Receivable
Credit – Revenue (Income Statement)
On the other hand, unearned revenue is mainly generated when the company receives compensation for the goods and services in advance.
This amount is, therefore, treated as a current liability because of the fact that goods and services against this particular amount are yet to be paid for.
Unearned revenue is also referred to as deferred revenue. The journal entry that is required to record unearned revenue is as follows:
Debit – Cash / Bank
Credit – Unearned Revenue (Current Liability)
However, once the amount for Unearned Revenue has been settled, it can be seen that it is treated as Income, and recorded as earned revenue for the period. The relevant journal entry required to record this is as follows:
Debit – Unearned Revenue (Current Liability)
Credit – Earned Revenue / Income (Sales)
Therefore, it can be seen that Unearned Revenue is a type of revenue, which is not yet earned because the company has not provided goods and services against the payment that has been received for these goods and services.
However, once the company has provided the goods and services, the amount is then treated as revenue in the Financial Statements.
Therefore, it is of primitive importance to ensure that the company is able to set a clear distinction between revenue and unearned revenue, so that the stakeholders of the company are able to identify the amount that has been generated as advances for the company, in addition to the actual amount that has been earned over the period of time.