Definition
The term revenue recognition before delivery refers to the process of recording revenue before goods or services are provided to a customer. The revenue recognition principle states a company can record revenue when they are realized or realizable, and earned. Under certain conditions, a company may be able to record revenue before the product is delivered to a customer.
Explanation
The FASB Concept Statement No. 5 states that companies cannot recognize revenues as being earned until two conditions are met. They must be realized or realizable, which means the goods or services have been exchanged for cash or claims of cash (credit), or realizable if the transaction involves an asset that can be converted to a known amount of cash. They must also be earned, which means the company has substantially completed what it needs to do in order to be entitled to payment.
Revenue can be recognized at the point of sale, before, and after delivery, or as part of a special sales transaction. The transactions that apply to recognizing revenue before delivery fall into three subcategories:
Prior to Production: includes scenarios involving the contracting of sales well ahead of delivery. For example, a dealer might purchase crops before maturity or a customer may enter into a contract to purchase a made-to-order product such as a large yacht.
During Production: includes longer-term contracts involving expensive products that may be of little value to anyone but the customer placing the order. Such arrangements may include periodic payments as milestones are achieved by the seller. For example, a software vendor might receive payment when an alpha, beta, and production-ready product are delivered for testing and final acceptance. Companies may use the percentage-of-completion approach to determine the amount owed to the vendor at various stages of production.
Completion of Production: includes precious metals that are mined and agricultural type products that might experience price fluctuations prior to physical delivery.
Example
Company XYZ has ordered ten customized transformers from Company A that need to be tailored to the exact specifications and dimensions outlined by Company XYZ. When special orders are placed, Company A requires a deposit of 40% prior to the start of production. Company A's selling price for each transformer is $12,000; thereby, requiring a deposit of $12,000 x 10 x 40%, or $48,000 prior to production.
The transaction to record the deposit paid by Company XYZ would be as follows:
| Debit | Credit | |
| Cash | $48,000 | |
| Payments in Advance of Construction | $48,000 |
When the transformers have been delivered to Company XYZ, the following transaction is recorded:
| Debit | Credit | |
| Payments in Advance of Construction | $48,000 | |
| Accounts Receivable | $72,000 | |
| Sales Revenue | $120,000 |
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