Businesses should understand the nuances of revenue recognition for a variety of reasons. Revenue recognition helps businesses comply with standards such as the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). It also guides internal stakeholders, from product development to sales. And it gives businesses more accurate and actionable insights about revenue, informing strategy, governance, and long-term business health.

Below, we’ll discuss what businesses should know about revenue recognition, including fundamental principles and common challenges. We’ll also explain how best practices can help businesses recognize revenue with more ease and accuracy. Here’s what you should know.

What’s in this article?

• What is revenue recognition?
  
• Accounting standards for revenue recognition
  
• Challenges of revenue recognition
  
• Revenue recognition best practices
  

What is revenue recognition?

Revenue recognition refers to the accounting practice of documenting and reporting income within a given period. It increases the accuracy of financial statements and involves recognizing revenue when it is earned, not necessarily when payment is received.

Accounting standards for revenue recognition

In the US, GAAP governs revenue recognition. Established by the Financial Accounting Standards Board (FASB), GAAP outlines specific methods for recognizing revenue from various types of transactions and engagements, including the sale of goods and the provision of services. Though many businesses also follow IFRS, GAAP remains the standard for US-based businesses.

The introduction of a new Accounting Standards Codification in 2014, commonly known as ASC 606, replaced industry-specific guidelines with a more generalized, principle-based approach. With the five-step model presented in ASC 606, businesses can better identify when and how much revenue to recognize. This model focuses on the transfer of control rather than the transfer of risks and rewards, which was the practice before.

Beyond the US, IFRS 15 is the international counterpart to ASC 606. Issued by the International Accounting Standards Board (IASB), IFRS 15 aims for global consistency in recognizing revenue from contracts with customers: 132 countries permit or require listed businesses to adhere to IFRS. These standards complement GAAP, making it easier for multinational corporations to harmonize their accounting practices across jurisdictions.

While the convergence of GAAP and IFRS to create a universal set of standards is still being debated among accounting industry and corporate leaders, businesses—regardless of their location—should adhere strictly to these accounting standards to remain compliant and build credibility with stakeholders. Adhering to these established guidelines creates a more straightforward audit process and reduces the risk of financial issues.

Challenges of revenue recognition

Revenue recognition can be complex. Though accounting standards such as ASC 606 and IFRS 15 provide guidelines, they can’t account for every possible scenario, leaving businesses grappling with several challenges.

• Contract complexity: With the rise of bundled offerings and long-term contracts that include various elements such as products, software, and services, it’s hard to know how much revenue to recognize from each component. This complexity escalates when businesses engage in multitiered sales arrangements, in which customers fulfill different pieces of the contract at different times.

• Performance obligations: It’s easier to recognize revenue when you’re selling a simple, one-off product, but it’s more complex if you’re providing ongoing services or software subscriptions. Knowing precisely when your business has fulfilled performance obligations can be confusing, especially when managing factors such as ongoing maintenance, upgrades, and other post-sale customer support.

• Variable consideration: For rebates, discounts, or performance bonuses that are conditional and subject to change, finalizing an amount that reflects the actual transaction price for the contract can require constant adjustment. These adjustments don’t just affect the balance sheet; they can also affect business operations and financial planning.

• Global regulatory and standards variations: Businesses that operate globally need to follow multiple accounting standards. Though there are similarities between US (ASC 606) and international (IFRS 15) standards, small differences still exist, requiring meticulous tracking and reconciliation.

• Evolving regulations: The regulatory environment is evolving, and businesses need to be aware of the latest changes to accounting standards. Noncompliance can lead to legal consequences and hurt a business’s reputation.

• Systems and technology updates: Many businesses still rely on legacy systems for their accounting needs. These systems might not be equipped to handle the intricacies of modern revenue recognition, leading to manual workarounds or costly software upgrades.

Businesses must focus on revenue recognition on an ongoing basis to handle these challenges, applying accounting acumen and operational insight.

Revenue recognition best practices

Adhering to best practices in revenue recognition can minimize errors, improve compliance, and increase the accuracy of financial reporting. Our recommended approach requires a blend of planning, process optimization, and technological advancement. Here are the best practices to consider:

• Standardize contract terms: Standardizing contract terms as much as possible can reduce complexity. Contract templates with clear terms and conditions can accelerate the negotiation process and make revenue recognition easier to calculate.

• Dedicated revenue team: Maintain a team focused solely on revenue recognition. This team can oversee complex contracts and collaborate with other departments to clarify performance obligations, payment terms, and other contract nuances.

• Continual education: Conduct regular training sessions to update your team on changes in regulations and accounting standards. This aligns everyone and encourages consistent, accurate revenue recording.

• Automated software: Invest in automated revenue recognition software to reduce manual calculation errors and save time. Look for software that can handle complex contracts and automatically update figures when terms change. These systems should scale as your business grows and adapt as standards change.

• Comprehensive documentation: Maintain a comprehensive record of each transaction, including changes in contract terms or variable considerations. Detailed documentation will help clarify any discrepancies, simplifying internal reviews and external audits.

• Regular internal audits: Conduct internal audits to check for compliance with accounting standards and verify the accuracy of revenue recognition. This will also prepare your business for external audits.

• Cross-departmental communication: Collaboration among sales, finance, and legal departments can streamline the contract review process. Each department can flag potential issues before they become a problem, increasing efficiency.

• Global standardization: If your business operates in multiple countries, standardize your revenue recognition practices to comply with local and international accounting standards and simplify the reporting process. This involves harmonizing methods and terms to satisfy GAAP and IFRS requirements.

• Financial planning adjustments: Revenue recognition policies can affect multiple areas of the business. Plan budgets and forecasts using the most current revenue data. This will help with decision-making across departments.

• Expert consultation: Seek the advice of legal and financial experts, particularly for complex or high-value transactions. Specialized advice can save time and help ensure your contracts comply with regulations.

Adopting these best practices can create a more efficient, compliant, transparent, and accurate revenue recognition process. Learn more about revenue recognition with Stripe.