What is Realization Concept of Accounting? Explanation with Example

realization concept

What is Realization Concept?

Realization Concept of Accounting states that revenue is only recognized when goods or services are delivered or rendered to the buyer.

Conservatism concept suggests the period when revenue should be recognized. However realization concept indicates that the amount of revenue that should be recognized from a given sale. Realization basically refers to the inflows of cash or claims to cash arising from the sale of goods or services.

It furthers states that the amount recognized as revenue is the amount that is reasonably certain to be realized. In other words, customers are reasonably certain to pay. But of course, there is room for differences in judgement as to how certain ‘reasonably certain’ is.

However, the concept does clearly allow for the amount of revenue recognized to be less than the selling price of the goods and services sold. One obvious situation is the sale of merchandise at a discount at an amount less than its normal selling price. In these types of cases, revenue is recorded at the lower amount, not the normal price.

Example of Realization Concept

Suppose a customer buys 5000 worth of items from a store, paying cash, store realizes 5000 from the sale. Now suppose, the same store sells a suit for 20,000. However the purchaser agrees to pay within 30 days, the store realizes 20,000 from the sale in the form of receivables. Provides that the purchaser has good credit record so that payment is reasonably certain.

A less obvious situation arises with the sale of merchandise on credit. When a company makes a credit sale, it expects that the customers will pay the bill. Experience may indicate, however, that not all customers do pay their bill. In measuring the revenue for a period, the amount of sales made on credit  should be reduced by estimated amount of credit sales that will never be realized that is by the estimated amount of bad debts.

For example, If a store makes credit sale of 1,00,000 during a period and if experience indicates that 3 percent of credit sales will eventually became bad debts, the amount of revenue for the period is 97,000 not 1,00,000.

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