If the goods have been shipped to the customer but not yet delivered, revenue recognition depends on whether the risks and rewards of ownership have been transferred to the customer.
If the risks and rewards of ownership have passed to the customer upon shipment, revenue recognition is generally appropriate, even if delivery has not yet occurred. This means that if the customer bears the risk of loss or damage during transit, revenue recognition is typically justified.
Another important consideration is whether the seller still maintains control over the goods after shipment. If control has been relinquished to the customer, revenue recognition may be appropriate. In summary, if the seller still maintains control over the goods or if other factors suggest that the risks have not transferred, revenue recognition may need to be deferred until delivery.
When an invoice is issued at the time of shipment, but revenue recognition is deferred due to certain conditions not being met, the invoice is still required to be recorded in the books of accounts. However, instead of recognizing revenue immediately, the transaction is recorded as a deferred revenue or unearned revenue, depending on the nature of the transaction and the applicable accounting standards.
ASC 606 Revenue from Contracts with Customers (US GAAP): Accounting Standards Codification (ASC) 606 provides guidance on revenue recognition under US Generally Accepted Accounting Principles (GAAP). It states that revenue should be recognized when control of the promised goods or services is transferred to the customer, either over time or at a point in time, in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. If these criteria are not met, revenue recognition should be deferred. While ASC 606 does not explicitly address the recording of invoices in cases of deferred revenue, the general principles it provides support the accounting treatment described.
IAS 18 Revenue (IFRS):
International Accounting Standard (IAS) 18 provides guidance on revenue recognition under International Financial Reporting Standards (IFRS). While IAS 18 primarily focuses on when revenue should be recognized, the concept of deferral is implied when revenue recognition criteria are not met. However, specific guidance on recording invoices in cases of deferred revenue can be found in other standards like IFRS 15 (Revenue from Contracts with Customers).
In India, the accounting standards for revenue recognition are outlined by the Institute of Chartered Accountants of India (ICAI). The primary accounting standard governing revenue recognition is Ind AS 115, which is largely converged with IFRS 15. Ind AS 115 provides detailed guidance on how revenue should be recognized and measured, and it aligns closely with IFRS 15.
IFRS 15 acknowledges that revenue recognition may need to be deferred if certain criteria are not met. For example, revenue recognition may be deferred if there are significant performance obligations remaining to be fulfilled, uncertainty exists regarding the collectability of the consideration, or other conditions necessary for revenue recognition are not yet satisfied.
When invoices are issued in such cases where revenue recognition is deferred, the transaction is typically recorded as follows:
Debit Accounts Receivable (or Cash) to recognize the amount billed to the customer.
Credit A liability account such as Deferred Revenue to reflect the unearned portion of the revenue. This indicates that the revenue has been invoiced but has not yet been earned.
In the context of GST/HST, there are specific considerations related to accounting for invoices when revenue recognition is deferred. The issuance of an invoice triggers the taxable event, meaning that GST/HST becomes payable upon the issuance of an invoice, regardless of when revenue recognition occurs. Businesses can claim Input Tax Credits (ITCs) for the GST/HST paid on purchases and expenses. However, the timing of claiming ITCs may differ from the timing of GST/HST remittance on invoices, subject to compliance with other conditions regarding availment of ITC.
In the United States, the rules regarding sales tax vary by state. Generally, sales tax liability arises at the time of sale or delivery of goods, rather than upon the issuance of an invoice. Each state has its own regulations regarding the timing of sales tax liability. If revenue recognition is deferred in the US, sales tax liability may still arise at the time of sale or delivery, depending on state regulations. The sales tax collected on the transaction must be remitted to the appropriate state tax authority in accordance with state laws.
In simple words, the timing of GST/HST or sales tax liability may not necessarily align with revenue recognition for accounting purposes. Businesses must understand the tax regulations in their respective jurisdictions and ensure compliance with invoicing, reporting, and remittance requirements. The adoption of the aforementioned accounting practise ensures compliance with the tax laws governing GST/HST and reduces the number of reconciliation items.