Lesson Storyline
In this lesson, we describe event-based revenue recognition (EBRR). You will learn which changes in the accounting principles require the use of EBRR and you will understand the advantages of this method for the period-end closing of a company.
You know that period-end closing in the plant and mechanical industry is very time-consuming: Unfinished products with large costs must be evaluated as work in process. Unfinished products will be billed to the customer at a later point in time. EBRR is also ideal for revenue recognition of subscription-based revenue models.
Leading accounting principles such as IFRS and US-GAAP require period-end accounting for quarter-end and year-end closing in order to show costs and revenues in the same period, when actual costs occur. It is an accounting approach for capturing revenues and expenses at the time of the period close or settlement, and not upon billing or receipt of payment. Accounting revenues in this way represents business results more precisely and is a decisive characteristic of the period calculation
The Legal Basis of EBRR
The Bike Company fulfills large production orders for customers purchasing hundreds of bikes. The sales invoice is issued upon delivery. The Bike Company also offers bicycle fleet management and maintenance as a subscription service to large customers. The customers pay for the service with an annual invoice for the entire year.
With traditional calculation models, the financial books of the Bike Company do not reflect reality for large periods of time. EBRR and modern accounting standards allow you to give a more realistic snapshot of the company's financials throughout the year.
What does EBRR do?
- It balances the calculated revenue with the actual revenue from the billing document.
- It balances the active Accruals and Deferrals with the liability A&D.
In the initial situation, the actual costs are 60% of the planned costs. This results in a percentage of completion (POC) of 60 percent. The POC method is to be applied for accounting according to IFRS and US-GAAP.
The system computes a calculated revenue respectively accrued/deferred assets by multiplying the POC with the plan revenue (A: 60%*2000 = 1200).
If an actual billing takes place (B), the actual revenue is offset against the calculated revenue. This means that you can see at any time how much of the planned revenue has already been recognized.
In addition to the actual posting, EBRR also immediately generates an accrual posting with the same amount of the billed revenue (C: 1200-800 = 400).
Because of EBRR’s accrual posting at any given point in time, the balance sheet and profit and loss statement are updated and reflect the profit situation correctly. This supports management and significantly reduces the effort involved in period-end closing and complies with the legal requirements of the accounting rules.
Without the use of EBRR, revenue would not be visible until the billing document for a sales order takes place: If the order volume is high, especially in the project business, this can only be done once agreed milestones of the project have been reached. Period accounting and periodic accrual are used to calculate the expected revenue when the result analysis is performed during period-end closing.
