What is the concept of revenue recognition?

The concept of revenue recognition is fundamentally about determining the timing of when revenue is recognized in the financial statements. The correct answer states that revenue should be recognized when it is earned and realizable. This aligns with the accrual basis of accounting, which emphasizes that revenue is recognized when a company has delivered goods or services to a customer, and there is a reasonable expectation that payment will be received.

Under this framework, revenue reflects the actual economic activity of the company during the period, providing a more accurate picture of financial performance. For instance, if a company provides services in December but does not receive payment until January, it still recognizes the revenue in December, assuming it has fulfilled its obligation and the payment is expected.

In contrast, recognizing revenue only when cash is received does not accurately depict the company's performance in the period when services or products were delivered. Similarly, recognizing revenue at the end of the accounting period or upon receipt of an invoice does not comply with the standards that emphasize recognition based on completion of the earning process and the realizability of collection. Therefore, the focus on earning and realizability is crucial for accurate financial reporting and understanding a company’s ongoing business activities.