The Revenue Realization Principle

Question: The revenue realization principle (within accrual accounting)

provides formal guidance for the timing of revenue reporting. It states in part that the earning process must be

substantially complete before revenue can be recognized. That seems reasonable. In the above example, the work

has only been performed for five days out of a total of thirty. That is not substantially complete. Why is any

accrued revenue recognized if the earning process is not substantially complete?

Answer: This question draws attention to a difficult problem that accountants face frequently in creating a fair

portrait of a company. The proper recognition of revenue is one of the most challenging tasks encountered in

financial accounting. Here, the simplest way to resolve this issue is to consider the nature of the task to be

performed.

Is this job a single task to be carried out by the company over thirty days or is it thirty distinct tasks to be handled

once a day over this period of time?

If the work of feeding and caring for the horses is one large task like painting a house, then the earning process

is only 5/30 finished at the moment and not substantially complete. No revenue is recognized until the work has

been performed for twenty-five more days. The previous adjusting entry is not warranted.