Time-saving tips to accurately record your transactions and create reports.
Financial insights you need to effectively scale your business.
Tax prep help to minimize your tax liability for stress-free filings.
Develop the skills you need to lead a more profitable business.
Expert CFO advice to protect your profits and control costs.
Current events and company updates that you need to know.
Money is constantly flowing in and out of your business, and it’s tricky to pin down the right time to recognize and record what’s coming in and what’s going out. So how do you know when to account for revenues and expenses?
Does revenue only count during production or when you receive payment too? What if your customers pay in installments? And the same is true about expenses. Is rent an expense only when you make your monthly payment, or do you calculate it annually?
Revenue recognition and expense recognition are more than flashy tax and accounting services terms—they’re timing strategies that take some thought and effort. Let’s dive into each so you and your bookkeeping and accounting team can keep more accurate financial records.
When do you recognize revenue in your reports, statements, and forecasts? Ideally, customers pay for products or services at the time of purchase, and the company gets to record those earnings. But there are situations where a seller takes time to deliver the goods.
For full revenue recognition, the revenue-generating activity (e.g., a sale) must be fully or essentially complete for it to count as revenue during a given accounting period. The revenue recognition principle serves as a solid guidepost.
Based on the revenue recognition principle, revenues are recognized when they are both earned and realized—not when a business receives money.
If you’re confused, don’t worry. It’s not every day that you’re sifting through tax and accounting services lingo (unless you’re a professional “nerd” like us).
The straight-up definition of revenue recognition might be a little confusing, so let’s dissect what it really means (insert mad scientist laugh here).
Sales provide a verifiable measure of revenue: the sales price. If you attempt to recognize revenue before you make an actual sale, you open the door to wide interpretations. Sales provide an objective and uniform test for revenue recognition.
On the flip side, when do you recognize expenses in your accounting documentation? The IFRS says, “Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.”
Expense recognition is about converting an asset into an expense once the asset has been consumed.
Expenses can be recognized immediately, such as:
This can happen in situations where the cash basis accounting model is used.
Expenses can also be delayed, such as:
This can happen where the accrual accounting model is used. To tie revenues and expenses together, the matching principle says companies should report expenses at the same time as the revenues they are related to.
It costs money to produce goods and provide services, and businesses frequently absorb these costs well in advance of making a sale. But by trusting the accounting model that matches your business needs (accrual or cash basis accounting), you can record revenues and expenses at the right times—not just when you receive or pay cash.
After all, shifting when you recognize expenses could make your business look more profitable than it is across accounting periods. But expenses offset your earned income, so they help you define how profitable you are during each accounting period. By tying revenues and expenses together appropriately, your income statements will be an accurate reflection of revenue- and expense-generating activities.
You want your reports and statements to be as accurate and as transparent as possible. Making sure you've recognized revenue and expenses at the right times will help you grow your business as you look for investors and satisfy shareholders.
Have a question about tax and accounting services? Need an expert partner to get your house in order? Get in touch with us. And if you aren’t sure if an outsourced partner fits the bill for your company, download our guide, Should I Outsource My Accounting Services? [With Checklist] to find out.
Ann Whittaker
