Revenue Recognition:
Revenue recognition is one of the four main principles in the US Generally Accepted Accounting principles (GAAP) which refers to how revenue is treated or recognized. Every company has to report their revenues. So what is revenue? Revenue is the total money, which a company receives for the goods or services it provides. So revenue is calculated by multiplying the price at which goods or services are sold by the number of units or amount. There few conditions under which revenue can be recognized. However, the two primary conditions are 1) The goods have been sold or a service has been rendered 2) There is some kind of assurance of the payment
In cash accounting, revenues are recognized as soon as the cash is received because cash is the only form of revenue that is possible. In accrual accounting, revenues are recognized as soon as the sale is made even if the cash is not received upfront. Generally the accrual accounting method is used by most of the companies as the cash is not received immediately after the sales are made.
There are two ways to report your revenues. The first one is the Gross Revenue Method. Calculating the revenue at gross means that you are actually recording all the revenues of the company on the income statement. In this method, the cost of sales and the cost of goods are reported separately. For example, if a company sells 10 pieces of a product for $100 each, then the revenues reported by the company by using the gross method will be $1000. Companies can also report the revenues by using another method called the Net Revenue Method. Calculating revenue means that you are actually recording only a commission on your net amount on your income statement. Even if there is no commission as such, a company can still report revenues at net by netting the amount sold to customers against the amount paid to the suppliers. Obviously, as only the net amount is shown in the second method, revenues reported by Net method will always be lower than revenue reported by Gross method for the same company. No matter which method a company chooses to report its revenues, its Net Income will be the same. Just the top line revenue figures of the company will be different.
The SEC has given some guide lines which the companies should use in deciding whether they should report their revenues by Gross method or by Net method. But these are just guidelines and not obligations. So companies are free to choose the way in which they report their revenues on the income statement. Due to this, analysts are having a hard time comparing companies in the same business as they use different methods of reporting revenues. One has to be really careful while looking at revenues of a company, as the revenues can be overstated by using a particular method which may be miss leading to an investor.
Reference: http://en.wikipedia.org/wiki/Revenue_recognition,
http://www.buzzle.com/articles/gross-vs-net-revenue.html
