Revenue of a Firm: Meaning, Recognition and Measurement

Let us make an in-depth study of the Revenue of a Firm. After reading this article you will learn about: 1. Meaning of Revenue 2. Recognition of Revenue 3. Measurement.

Meaning of Revenue:

According to Paton and Littleton, revenue is the product of the entity which refers to the goods and services created during a specific time span by an enterprise. American Accounting Association, Committee on Accounting Concepts and Standards, embraces the above ideas and defines- “Revenue……………………….. is the monetary expression of the aggregate of products or services, transferred by an enterprise to its customers during a period of time“.

The operation of a business enterprise consists of a continuous process of repeated conversion of economic resources and their exchanges. Generally, these conversions and exchanges are made at higher values. In other words, the values realised or earned are higher than their respective values which are lost in exchanges and conversions.

As such, net assets of the business increase by the amount of excess values which is earned or realised.

Recognition of Revenue:

Revenue is considered or recognised in accounting as having been earned on the date on which it is realised (even if the same is not received in cash within the said period). That is, it refers to the timing of its recognition in accounts. Because, earning of revenue and the receipt of cash for the same are not practically identical.


On the contrary, they are totally different. Therefore, revenues accrued in the accounting period in which they are earned, i.e., revenues, are measured in accordance with the actual concept of accounting and, as such, the same is treated as theoretically realised though not practically realised/received in cash.

In determining whether a particular revenue should be recognised at a particular point of time, regard must be made to:

(i) The amount involved should be capable of being measured objectively;


(ii) It must earn revenue; and

(iii) The revenue must have been realised in the form of an asset or assets (usually cash or receivables) or by the extinction of a liability.

Although the particular nature of the firm will determine the time of revenue recognition, the following criteria are widely used, in general, in order to determine the point of time:

(a) If the amount of revenue is ascertained with accuracy and the receipt of the same is certain, in that case, realisation of revenue may be recognised and may also be treated as earned in the books. However, in the opposite case, i.e., if the revenue cannot correctly be measured and, at the same time, the receipt of the same is uncertain, no revenue can be recognised as realised and, as such, must not be recorded as earned in the books.


There will be an exception to the rule if there is a guaranteed market at a fixed price. Because the firm, in that case, is able to sell its products at a guaranteed price, e.g., rare metals.

(b) The commonly accepted evidence of realisation of revenue is the market transactions (i.e., the actual sale of goods or services) since there is an applied transaction with an outsider involving an exchange of the output for a money/monetary claim.

The accountants recognise revenue at such a stage due to:

(i) The expected selling price or the possibility of selling the output at a given rate is uncertain before the point of actual sale, particularly in case of a new product or a non-standardised product which, in other words, eludes the accountant of adequate evidence to justify the upward revision in the value of the product.


(ii) Actual selling of goods and services constitute the significant step for the purpose of earning revenue. It may so happen that the recognition of revenue is delayed, even when a sale has been made, due to some unusual circumstances prevailing in the business.

As a result of this problem, the AICPA (Accounting Standard Division) has suggested some conditions for recognising the sales revenue:

(i) “The selling price should be substantially fixed at the date of the exchange of goods or services.

(ii) The buyer has either made full payment or has accepted a debt, the repayment of which is not to be postponed or deferred until the merchandise is resold by him.

(iii) The obligation to the seller by the buyer is to change in no way because of the loss of goods in the latter’s custody.

(iv) The seller, in his part, must not have any significant obligation for future performance to bring about a resale of the merchandise sold by him to the buyer and held in the latter’s custody.

(v) Further returns of the merchandise can be predicted with reasonable accuracy.

(c) If there are inflow of resources without supplying goods and services in an accounting period which will be supplied in a subsequent date or in an accounting period, the said inflows can never be treated as revenue earned in the accounting period when the same are actually received in cash.

On the contrary, they should be considered as advance payment and must be shown in the liability side of the Balance Sheet in the particular accounting period when such payment is received. They should be considered as revenue realised when the goods and services will be provided in the future accounting period, e.g., subscription/rent received in advance. It is evident from the foregoing discussions that the revenue is recognised as earned/realised at the point of actual sale of goods and services.

However, this principle has some exceptions:

(i) Revenue Recognition on Completion of Production:

If revenue is measured objectively prior to the date of exchange between the buyer and the seller, the revenue is recognised on the earlier date. In other words, if the business deals with standard products which are sold in an organised market at a price which can be determined at any point of time, e.g., gold mining- revenue is recognised in the accounting period in which the gold is mined and not in the period in which it is sold.

(ii) Revenue Recognition before Completion of Production:

It is known to all that actual sale basis of the revenue recognition is not followed in case of long-term contracts. If the revenue is recognised only on the completion of the contract, recognition of revenue at the final point of sale would simply result in a highly distorted picture of income for the different accounting periods.

In order to avoid such problems on the basis of progress of contract, the portion of the construction which has been completed and approved is revalue and, on that basis, a percentage to the ultimate contract price is recorded as a realised revenue even before the contract is completed.

(iii) Non-Recognition of Revenue in Case of Doubt:

This method is particularly applicable where the sale transaction is deemed not to be adequate and, as a result, additional evidence in support of such transaction may be considered necessary. Sometimes, in a sale transaction, some conditions may be imposed which may express positive weakness for rendering the evidence of sale inadequate, in order to recognise the revenue.

For example, in case of a hire purchase transaction—where the purchaser has a right to cancel the contract and the seller has a right to repossess the asset. In this case, revenue is recognised only by the aggregate amount of instalment (which may have fallen due during the specific accounting period which have already been realised in cash or will be realised definitely).

(iv) Revenue Recognition against Cash Payment:

This method is widely accepted by professional people who are engaged in professional services and maintain cash basis of accounting for the purpose of recognition of revenue. Here, the revenue is not recognised till the payment is received in cash. So, the revenue is treated as realised for the period only when the cash is received and not in the period where the services are actually supplied, although, for recognising revenue, it is practically impracticable.

Measurement of Revenue:

Revenue is properly measured either by the exchange value of the product or services of the firm. This exchange value actually reveals the cash equivalent or the present discounted value of the money which is received from the revenue transaction. This may be similar to the price established in the transaction.

For this purpose, proper allowance must be made in order to wait for final collection. For example, a cash sale of Rs. 1,000 will produce a revenue of Rs. 1,000 but if the payment is made after a year, it produces a revenue which will be less than Rs. 1,000, since question of discount will appear in the latter case. If the waiting period is very short, naturally, the discount factor may be ignored.

The above criterion for the purpose of measurement of revenue relates to the present value of money or its equivalent which is finally received from the revenue transaction since all returns, trade discounts and other reductions are subtracted from the revenue so earned. Cash discounts and bad debt, if any, are also to be deducted.

It is to be noted that cash discounts are allowed to customers for two purposes:

(i) To reduce the amount of bad debt losses, and

(ii) To equate the money-value received within the discount period with the present discounted money value (which will be received under the granted credit terms at a later date).

Practically, if the rate of cash discount was fixed rationally, the sellers would be less interested in whether they received the net amount or gross price minus certain amount of expected bad debt losses. In this context, cash discounts and expected bad debt losses are to some extent similar.

Comments are closed.