Realization Principle

Realization principle is also known as the Revenue Recognition principle.

Realization principle guides when to recognize the revenue.

GAAP requires that two criteria must be satisfied in recognizing revenue:

1.The earnings process is judged to be completed or virtually complete.
2.There is reasonable certainty as to the collectability of the asset (usually cash) to be received.

In short, Revenue must be recognized the earnings process is virtually complete and collection is reasonably assured.

The primary earning activity which triggers revenue recognition is known as the critical event.  The critical event for many organizations occurs at the point of sale.  This usually happened when the goods are delivered or title and ownership is transferred to the buyer, or the services is already rendered or performed.

The timing of revenue recognition is a key element in the measurement of earnings.  In preparation of financial statements, the income must be reported at the proper time period otherwise, this may result to overstatement or understatement of revenue and net income. Hence, the revenue recognition criteria helps ensure that proper recording is made.

Note that the revenue recognition allows the implementation of the accrual accounting model, where revenue must be reported in the period when it is earned, not necessarily when the cash is actually received.

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