Realization principle of accounting – Definition
The realization principle of accounting revolves around the determination of the point of time when revenues are earned. The concept followed is that revenue is realized when goods and services produced by a business enterprise are transferred to a customer either for cash or some other asset or for a promise to pay cash or other assets in the future.
A very important issue is that when the profit should be considered? The realization principle of accounting is one of the pillars of modem accounting; it gives birth to the Accrual System of Accounting.
This principle guides that the profit should be realized when the goods are transferred to the buyer. According to this concept, revenue should be recognized when goods are sold or services are rendered, Whether cash has received or not. Similarly, an expense should be recognized when goods are bought or services are received, whether cash has paid or not.
According to this concept, revenues are not recognized unless they are realized. The point at which the revenue is realized will vary depending upon circumstances. For example, revenue is realized when goods are delivered to customers and not when the contract is signed to deliver the goods.
The important thing is that revenue is earned only when the goods are transferred or when services are rendered, following the legal principle relating to the transfer of property. There must also be a reasonable expectation that the revenue will be realized either presently or in the future. The thing to note is that revenue is not earned merely when an order is received. Nor does recognition of the revenue have to wait till actual cash is paid.
Consider a case where an order was received in April, the goods were transferred in May and the payment was received in June. The revenue would be deemed to have been earned in May when the transfer took place notwithstanding the fact that the order was received in April and cash was received in June.
If Mr. A sold goods worth of $2,000 to Mr. B, the later agrees on the proposal that goods will be transferred after 15 days. After receiving goods Mr. B makes payment after 10 days. Here according to the Realization Principle of Accounting, sales are considered when the goods are transferred from Mr. A to Mr. B.