According to GAAP, when should revenue be recognized?

According to GAAP, when should revenue be recognized?

• A. When cash is received
• B. When it is earned and realizable
• C. When it is invoiced
• D. When a contract is signed

Answer: (B)

The reasoning behind recognizing revenue when it is earned and realizable is rooted in the revenue recognition principle under Generally Accepted Accounting Principles (GAAP). This principle states that revenue should be recognized in the accounting period when it is earned, which typically occurs when the goods or services have been delivered or rendered, and there is reasonable assurance that payment will be received, meaning the revenue is realizable. This approach aligns with the accrual basis of accounting, which emphasizes recording transactions when they occur, rather than when cash changes hands. Focusing on when the revenue is earned helps ensure that financial statements accurately reflect the company’s performance during a specific period, providing a clearer picture of ongoing operations. In contrast, recognizing revenue based solely on cash receipt, invoicing, or signing a contract does not adequately reflect the completion of the delivery of goods or services and the certainty of collection, which can lead to reporting inaccurately inflated or deflated financial results. Recognizing revenue based on its earning status ensures that financial data remains relevant and reliable for decision-making by stakeholders.

The reasoning behind recognizing revenue when it is earned and realizable is rooted in the revenue recognition principle under Generally Accepted Accounting Principles (GAAP). This principle states that revenue should be recognized in the accounting period when it is earned, which typically occurs when the goods or services have been delivered or rendered, and there is reasonable assurance that payment will be received, meaning the revenue is realizable.

This approach aligns with the accrual basis of accounting, which emphasizes recording transactions when they occur, rather than when cash changes hands. Focusing on when the revenue is earned helps ensure that financial statements accurately reflect the company’s performance during a specific period, providing a clearer picture of ongoing operations.

In contrast, recognizing revenue based solely on cash receipt, invoicing, or signing a contract does not adequately reflect the completion of the delivery of goods or services and the certainty of collection, which can lead to reporting inaccurately inflated or deflated financial results. Recognizing revenue based on its earning status ensures that financial data remains relevant and reliable for decision-making by stakeholders.