Revenue realisation is the process of recognising revenue on a company’s financial statements when it is earned and realisable – regardless of when the cash is received. This concept is governed by accounting principles that ensure revenue is recorded only when goods or services have been delivered, the amount is measurable, and there’s an expectation the funds will be collected. Although revenue realisation bears similarities to revenue recognition, they are two distinct concepts.

Below, we’ll cover the differences between the two accounting processes, how revenue realisation works, and best practices for your business to follow.

What’s in this article?

• Revenue realisation vs. revenue recognition
  
• Factors that influence revenue realisation
  
• How revenue realisation works in the revenue recognition process
  
• How revenue realisation varies across different industries
  
• Common issues in revenue realisation
  
• Best practices for revenue realisation
  

Revenue realisation vs. revenue recognition

Revenue realisation and revenue recognition are related but distinct accounting concepts that determine when and how revenue is recorded on a company’s financial statements. Realisation is about the earning process, while recognition is about recording revenue on the books. Here’s a closer look.

• Revenue realisation refers to the point at which revenue is considered earned. It focuses on when a business has substantially completed its side of a transaction, such as delivering goods or providing services. Revenue is “realised” when it is earned and there is a reasonable certainty of collecting payment.

• Revenue recognition is the accounting principle that dictates how and when revenue should be recorded in the financial statements. It involves following specific criteria – such as the International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP) – to determine the timing and amount of revenue to be recognised. Revenue is “recognised” when it is both earned (realised) and can be reliably measured.

Factors that influence revenue realisation

Several factors influence revenue realisation and when a company can consider its revenue ready for recognition. These include:

• Transfer of control: Revenue is typically realised when control of goods or services passes from the seller to the buyer. Control involves the ability to direct the use of the asset and substantially obtain its benefits. This transfer can occur at a particular point in time (e.g., delivery of a product) or over time (e.g., services provided over a contractual period).

• Payment received or certainty of payment: For revenue to be realised, there must be a reasonable expectation of payment from the customer. This doesn’t mean payment is received up front, but the company should assess the customer’s creditworthiness and terms of the sale to decide that collection is likely.

• Completion of performance obligations: Revenue can only be realised when the company has substantially completed the performance obligations as stated in the contract. This means the goods must be delivered or the services must be performed as agreed.

• Legal title and risks transferred: Revenue realisation often coincides with the transfer of legal title in addition to the risks and rewards associated with ownership. If the buyer has accepted the goods or services, and the seller no longer bears substantial risk or reward, revenue can be realised.

• Contract terms and conditions: The specific terms of the sales contract (including return policies, warranties, or customer acceptance clauses) can impact revenue realisation. If a contract allows for returns or includes extended warranties, companies might delay revenue realisation until those conditions are reasonably satisfied.

• Measurement and estimation of revenue: Realisation requires that revenue can be reliably measured. Any uncertainty around the amount, such as variable consideration (e.g., discounts, rebates, refunds), can delay realisation until a reliable estimate is possible.

• Compliance with accounting standards: Revenue realisation must comply with the specific criteria set by relevant accounting standards (e.g., IFRS 15, ASC 606). These standards contain detailed steps to determine when control is transferred and when revenue is realised.

How revenue realisation works in the revenue recognition process

Revenue realisation is a step in the revenue recognition process. According to accounting standards, revenue is recognised in the financial statements when it is realised. This means the revenue is recorded in the accounting period when the conditions for revenue realisation have been fulfilled, not necessarily when cash is received.

Here is the five-step model of revenue recognition that outlines how companies need to account for revenue.

• Identify the contract with a customer: This step involves determining if there’s a contract binding the parties to their obligations.

• Identify the performance obligations in the contract: Here, the company breaks down what exactly it owes the customer – such as a product, a service, or a combination of both. Realisation depends on fulfilling these promises.

• Determine the transaction price: The company calculates how much it expects to be paid. For realisation to happen, this amount must be clear and collectible. The company must account for any potential discounts or uncertainties.

• Allocate the transaction price to the performance obligations: The company must assign the right part of the total price to each promise made to the customer. Revenue is realised as each promise is fulfilled.

• Recognise revenue when (or as) obligations are satisfied: The business records revenue when (or as) it fulfils its end of the deal, whether by delivering a product or completing a service. When the company has done what it promised and can expect to get paid, revenue is realised. Once the revenue is realised, it can be recognised.

How revenue realisation varies across different industries

Revenue realisation can look quite different across different industries because the nature of goods and services, how they are delivered, and the terms of payment all vary. Here’s a breakdown of how it can differ.

• Retail and e-commerce: In retail, revenue is typically realised at the point-of-sale (POS) when the customer takes ownership of the product – whether in store or through delivery. But in e-commerce, companies need to account for possible returns or refunds, which can delay revenue realisation.

• Software and technology: For software companies, revenue realisation often depends on the delivery model, specifically whether it’s a one-time licence, a subscription, or software-as-a-service (SaaS). For SaaS products, revenue is realised over the subscription period as the service is provided rather than up front. If it’s a long-term contract, the company gradually recognises revenue as it fulfils its promises over time. For one-time purchases, revenue is realized when the licence term begins or when the customer can begin using the software.

• Construction and real estate: In construction (especially for longer projects), revenue is realised over time based on the percentage of the project completed, milestones achieved, or costs incurred. This method, known as “percentage of completion,” allows companies to realise revenue in chunks as the project progresses rather than waiting until the entire project is finished.

• Telecommunications: Telecom companies often have complex revenue structures due to bundled services (such as combining phone, internet, and TV). Revenue realisation here involves separating each service and recognising revenue as each is delivered. For instance, a phone company contract might bundle hardware (e.g., a phone) and a monthly service plan, so the company will need to split the revenue and recognise each purchase separately.

• Manufacturing: For manufacturers, revenue is typically realised when the goods are produced, delivered, and control is transferred to the buyer. If there are terms around delivery or if the product is customised, realisation can depend on when the customer accepts the delivery or when the customisation meets specific standards.

• Hospitality and travel: Hotels, airlines, and other travel services realise revenue when service is rendered. For instance, a hotel recognises revenue when the guest checks in and stays, not when the booking is made. The timing of realisation can also vary depending on cancellation policies or non-refundable deposits.

• Healthcare: In healthcare, revenue realisation depends on when services are provided to patients and the timeline for insurance reimbursement. Realisation can be delayed over insurance approvals.

• Professional services (consulting, legal, etc.): For companies that provide professional services, revenue realisation typically takes place as the service is performed – particularly if it’s a project-based arrangement. If the provider is paid through an ongoing retainer, revenue might be realised evenly over the period covered.

• Subscription-based media and publishing: In media, publishing, and online content, revenue realisation happens over the subscription period. For annual subscriptions, the revenue is spread out month by month as the service is delivered.

Common issues in revenue realisation

Revenue realisation can be complex. It often involves making estimations and judgments that can impact financial reporting. Here are some common areas where businesses can struggle when managing revenue realisation.

• Consideration of variables: Many contracts contain elements such as discounts, rebates, refunds, performance bonuses, or penalties. Businesses must correctly estimate the monetary value of these elements to accurately realise revenue. If these estimates are off, it can lead to over- or understating revenue. In industries such as healthcare or telecommunications – where the final amount to be received can depend on future events (e.g., patient insurance approvals, customer usage levels) – getting these estimates right can be particularly challenging.

• Transfer of control: Businesses must determine exactly when control of a good or service has transferred to the customer. In construction or software services, the timing can be gradual, making it more difficult to determine when revenue should be realised. Misjudging this can lead to premature or delayed revenue recognition.

• Collectability: Businesses can only realise revenue when there is reasonable assurance of payment. This can be challenging, especially when conducting transactions with customers who might have uncertain credit or when handling international contracts that carry varying levels of risk.

• Returns and refunds: In industries where returns are common, such as retail and e-commerce, businesses must estimate the amount of expected returns and account for them up front. Underestimating returns can inflate revenue figures, while overestimating can deflate them. Both impact the bottom line.

• Long-term contracts: In industries such as construction or aerospace where projects can take years to complete, businesses must engage in detailed tracking of costs, milestones, or performance to recognise revenue over time. Miscalculations or overly optimistic forecasts of project completion can lead to inaccurate revenue realisation.

• Multi-element arrangements: When a contract involves multiple products or services (such as a hardware-software bundle), businesses must split the transaction price appropriately and recognise each element separately. Misallocating revenue between different parts of the arrangement can cause timing issues in realisation.

• Contract modifications: Changes in contractual terms after a deal is signed can also impact revenue realisation. Businesses must reassess how revenue will be realised if a customer makes changes such as requesting additional features in the middle of the project or changing delivery timelines. Failing to properly account for these modifications can lead to errors.

• Subjectivity: Businesses must often make subjective judgments about when revenue should be realised. These can be influenced by the pressure to meet financial targets, which creates a risk of earnings manipulation – where revenue is realised either too early or too late to shape earnings reports.

• Accounting standards: Businesses must navigate standards such as IFRS 15 or Accounting Standards Codification (ASC) 606. This navigation requires a thorough understanding, since misinterpretations or failure to comply with these standards can lead to incorrect revenue realisation that might require restatements or audits.

• Economic changes: Economic changes such as a downturn or fluctuating market conditions can impact customer behaviour and payment patterns. Companies must continually reassess the certainty of payment and adjust their revenue realisation estimates accordingly.

Best practices for revenue realisation

With these common challenges in mind, here are some best practices that can make the revenue realisation process more manageable.

• Contract review: Set up cross-functional contract review teams involving legal, sales, and finance to evaluate terms up front. Identify clauses around delivery, performance milestones, customer acceptance, returns, and variable pricing. Develop a checklist that pinpoints revenue realisation risks (such as non-standard payment terms or bundled deliverables) and push back on risky terms during contract negotiations.

• Revenue realisation policies: Develop multiple scenario-based revenue realisation policies in line with specific contract types, industries, or customer segments. Use decision trees to navigate scenarios such as contracts with multiple performance obligations or milestone-based payments.

• Rolling estimation: For companies with variable consideration, set up a rolling estimation review process (quarterly or monthly) for key contracts. Leverage historical data and predictive analytics to refine your estimates on rebates, discounts, or usage-based fees. And to more accurately forecast these variables and avoid surprises, use machine learning models that account for external factors (e.g., economic indicators, industry trends).

• Revenue recognition software: Deploy advanced revenue recognition software that allows for granular analysis. For example, your system might realise revenue based on percentage-of-completion for projects, time-based for subscriptions, and delivery-based for products. Automate triggers for realising revenue when specific contractual obligations are met and build in controls to flag any deviations from expected revenue patterns that could indicate errors or potential manipulation.

• Complex or high-value contracts: Form a specialised task force within the finance team to tackle complex or high-value contracts separately. This team needs a deep understanding of revenue standards and a focus on contracts that require significant judgment or are prone to variability such as multi-element arrangements or international deals with different legal interpretations of “control.”

• Contract modification: Establish a step-by-step protocol to re-evaluate performance obligations, and adjust revenue allocation and timing when contracts change. Create a workflow where modifications trigger mandatory reviews by both the original contract owners and finance leaders. Implement contract lifecycle management (CLM) software to track modifications and integrate these changes directly into revenue realisation systems.

• Predictive analytics: Use predictive analytics to assess the likelihood of payment collection based on customer behaviour patterns, macroeconomic conditions, and credit scores. For high-risk customers, consider realising revenue only when payments are received.

• Scenario planning: Perform scenario analysis that models how changes in contract terms, customer behaviour, or market conditions affect revenue realisation. Develop contingency plans to adjust your financial statements and disclosures in case of major contract cancellations or regulatory changes in a key market.

• Financial forecasting: Connect your revenue realisation system with your financial forecasting tools for real-time updates. This allows finance teams to dynamically adjust revenue forecasts based on current realisation patterns, and reduce the gap between projected and actual revenue.

• Internal audits: Run internal audits specifically on revenue realisation at least semi-annually with a focus on high-risk areas, such as new product lines or international markets. Use forensic accounting techniques to spot early signs of potential misstatements or compliance issues.

• Revenue realisation dashboard: Build a dashboard for visibility into key metrics such as realised versus unrealised revenue, aging of revenue realisations, variance from expected recognition patterns, and deviations from revenue policies. Use these insights to make quick adjustments and keep management and auditors aligned.

• Team training: Conduct workshops that involve real-world contract scenarios, case studies on complicated revenue situations, and mock audits. Train teams to think critically and use their judgment swiftly so they are better equipped to handle grey areas or high-stakes situations.