Revenue Recognition

Revenue is the sum of all the product and service charges for which customers are liable. Revenue can be tracked on a daily or monthly basis.

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Earned and Unearned Revenue

Revenue is defined as earned or unearned. In general, revenue is considered earned when the customer has received 100% of the purchased product or service. Revenue is unearned if the customer has not yet received 100% of the product or service. However, if the product or service is delivered incrementally over time (such as a subscription to media content), the corresponding revenue can be converted to earned revenue incrementally over time, as long as the customer is receiving incremental delivery. Revenue can be earned before it is billed. A given charge does not have to be billed to be considered revenue.

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Revenue Recognition

Revenue recognition is the act of recording revenue in the general ledger (G/L) of your merchant organization. The process of revenue recognition enables you to convert unearned income to earned income. Revenue can be fully recognized when it becomes earned revenue. As described above, revenue is earned when the product or service is delivered, either in a one-time purchase or in an incremental delivery. Recognition for unearned revenue must be deferred until the customer receives some portion of the product or service and the revenue becomes earned. Revenue recognition occurs independently of when a customer receives an invoice or makes a payment. For example, when a customer purchases a new car, the car dealer recognizes the revenue for that sale when the customer drives the car off the lot. The customer can pay in full at the time of purchase or finance the purchase over time, but the dealer fully recognizes the entire purchase price at the time the customer takes possession of the car. With an incremental service, such as a monthly subscription, the revenue for a given time period is earned when the customer receives access to the content for that time period.

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Revenue Recognition Models

Rules for revenue recognition can vary widely among organizations. Revenue recognition rules are based on Vender Specific Objective Evidence (VSOE), which describes how your organization has done business in the past and how the given product or service is used by customers. In practice, two different services that are invoiced and paid for in a similar manner, such as two monthly recurring charges, can be subject to different revenue recognition rules, based on the nature of the particular service. Most revenue recognition rules align with one of the models described below:

• Fixed: Both the amount to be recognized and the duration over which it is recognized are fixed. For example, an annual charge of $120 recognized over 12 months or four quarterly charges of$30 each, the sum of which is recognized over 12 months.
• Variable: Either the amount to be recognized or the duration over which it is recognized can vary. For example, four quarterly charges of $15,$20, $35 and$50, the sum of which is recognized over 12 months.
• Split: A single charge that is recognized in two or more increments. For example, a $50 activation fee where 50$25) is recognized on order and 50% is recognized on completion of activation.
• Dependent: Revenue is not recognized until the completion of some event has occurred, that is, the goods have been shipped, the service has been activated, or the charge has been paid. For example, the customer can purchase and pay for five days of training, but that revenue is not recognized until the training has actually been performed. Also, certain charges are not recognizable until they are paid. For example, interest charged on a past-due invoice is typically not recognized until the customer pays the interest charge.
• Consumption: Revenue is recognized as the service is consumed. For example, the customer has paid $50 for 50 minutes of service to be used any time over the next 12 months.$1 is recognized for each minute of service as the customer consumes it, until the service is fully consumed and the total $50 is recognized.

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Tracking Recognized Revenue

Organizations track revenue on either a daily or a monthly basis.

• With some exceptions, organizations that operate on a cash basis track revenue on a daily basis. These organizations tend to have few accounts receivable, because they bill and collect for services before providing the customer access to the service (such as a prepaid service plan). For organizations that track revenue on a daily basis, it is important to recognize revenue the day it happens, in real or near-real time. Companies that track revenue daily also maintain a monthly record of revenue.
• Organizations that operate on a receivables basis track revenue on a monthly basis. These organizations generally bill for the service in advance but collect payment after the customer has received access to the service (such as monthly billing, or a “buy now, pay later” plan). For organizations that track revenue on a monthly basis, it is important to accurately record the month in which the revenue occurs.

B2C (business-to-consumer) enterprises tend to operate on a cash basis, while B2B (business-to-business) enterprises tend to operate on a receivables basis.

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Calculating Revenue Increments Over Time

In determining the amount of revenue to be recognized, care must be taken in rounding revenue amounts that are recognized incrementally over time. For example, a $13 charge tracked monthly over 12 months is$1.0833333 dollars per month. This monthly amount must be rounded to whole dollars and cents, in such a way as to recognize the full $13 charge by the end of the 12-month term. To ensure accuracy, the amount to be recognized in each increment must be calculated by subtracting the amount recognized to date from the total amount, and then dividing by the remaining increments. Though the differences in rounding may seem trivial, when compounded by many thousands of subscribers, the ability to accurately allocate earned revenue to the appropriate month can have a direct impact on your financial reporting. The following table provides an example of rounding a $13 charge in monthly increments over 12 months. The following table provides an example of rounding a $13 charge in daily increments over 30 days.

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Credits, Refunds, and Prorated Charges

Applying credits, processing refunds, and calculating prorated charges (for example, for upgrades) can have a direct impact on when revenue can be recognized. Revenue recognition for such transactions varies according to circumstances. When issuing a credit or refund, it is important to know the reason the credit or refund is being given to accurately determine the impact on revenue. Likewise, when recognizing revenue for prorated charges, it is important to know when the upgrade or service related to the charge will take effect.

• A goodwill credit typically has a negative effect on revenue (either directly or through a contra revenue account), and can be 100% recognized at the time the credit is given.
• For general G/L posting purposes, a refund can have the same effect as a credit (immediate reduction of revenue). In some cases, the refund must be split between revenue and deferred revenue, if the charge being refunded is not yet fully recognized.
• For prorated charges related to an upgrade, the revenue can be 100% recognized as of the completion of the order, if the upgrade occurred in the past (that is, the upgrade was made effective as of the first of the current month). If the upgrade takes effect as of the order date, the revenue can be recognized incrementally.

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Service Cancelation

When a service is canceled for any reason, any remaining unrecognized revenue pertaining to that service can be immediately recognizable. For example if you offer a year-long service for $120 a year and the customer cancels that service after two months, any amount of the original$120 that has not already been recognized can be immediately recognizable as revenue. This can be true even if the customer will receive a refund for the unused portion of the service.

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Recognizing Revenue Over Expected Subscriber Lifetime

In some cases, a merchant recognizes the revenue for a charge over the expected lifetime of the subscriber (the length of time that the subscriber is expected to be active with the merchant organization) because the service is delivered constantly for as long as that subscriber is active. For example, if you provide a monthly service for a recurring charge and also provide integration service as a onetime charge, the revenue for the integration service can be recognized over the expected subscriber lifetime. The expected subscriber lifetime can be somewhat fluid and can increase or decrease over time. A merchant offering a monthly recurring service can have an expected subscriber lifetime of one to two years because most subscribers drop the service after that length of time. However, if the merchant introduces a multiple yearly recurring service (allowing the subscriber to pay for three or more years at a discounted rate), the expected subscriber lifetime can increase to three or four years. As the expected subscriber lifetime changes over time, the rate of revenue recognition also changes for any charges that are recognized based on the expected subscriber lifetime.