Revenue: Meaning, Concept and Activities

In this article we will discuss about Revenue:- 1. Meaning of Revenues 2. Concepts of Revenue 3. Activities.

Meaning of Revenues:

Revenues are earned from the sale of goods or services done by a business entity to the others. The business entity receives or will receive (in future) cash or something else of value. Generally cash is received immediately from the sale of goods or rendering services. If goods or services are sold on credit, then cash will not be received immediately but at a future date.

In this situation, it is assumed that the business enterprise has received/created, accounts receivable/debtors. In both the cases, i.e., whether goods and services are sold on cash or credit, revenues are considered to be earned by the business entity. Further, the gross increase in assets and capital eventually pertains to cash.

Revenues earned results into inflows and gross increase in the value of assets and capital of a business entity and outflows of goods or services from the firm to its customers. Generally, revenues are defined differently taking broader or narrower views about the components of revenue.

Concepts of Revenue:

Broader Concept of Revenue:

The broad or comprehensive concept of revenue includes all of the proceeds from business and investment activities. This view accepts revenues as all changes in the net assets, resulting from ordinary activities (or revenue producing activities) and other gains or losses resulting from the sale of fixed assets and investments.

The broader view is taken by AICPA (USA) when it defines revenues as follows:

“Revenue results from the sale of goods and the rendering of services and is measured by the charge made to customers, clients or tenants for goods and services furnished to them. It also includes gains from the sale or exchange of assets (other than stock in trade), interest and dividends earned on investments, and other increases in the owner’s equity except those arising from the capital contributions and capital, adjustments.”

Narrower Concept of Revenue:

The narrower concept considers revenues resulting from the primary or normal activities of a business entity and thus the narrower view of revenues excludes investment income and gains and losses on the disposal of fixed assets.

The Institute of Chartered Accountants of India (ICAI) defines revenue in its Accounting Standard (AS) No. 9 as following, taking a narrower view:

“Revenue is the gross inflow of cash, receivables or other consideration arising in the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of, commission and not the gross inflow of cash, receivables or other consideration.”

The FASB (USA) also takes a narrower view while defining revenues:

“Revenue are inflows or other enhancements of assets of an entity or settlements of its liabilities (or combination of both) during a period from delivery or producing goods, rendering services, or other activities that constitute the entity’s on-going major or central operations.” Thus, revenues will be increase in asset values in the firm due to the primary operations of the business and on account of production or sales of product or services.

The narrower concept makes clearly the distinction between revenues and gains. Gains are increases in net assets from peripheral or incidental transactions and from other events that may be largely beyond the control of the firm whereas revenues rate to the on-going major or central operations.

Revenues represent increases that occur because the firm undertakes certain activities. In other words, there is performance by a business entity. Revenue comes about because an enterprise does something to make it happen. In particular, what it does is to produce and sell a product or service.

Revenue is not simply a sum of money, but it is indicative of the accomplishment of the firm. It is a measure of the company ‘gross performance’ as a profit making enterprise. When expenses are seen as representing the ‘efforts’ of the firm, the matching of revenues and expenses results in income, the ‘net accomplishment’ of the firm.

Taking a narrower concept of revenues, the following items are not included within the definition of revenue:

(a) Realised gains resulting from the disposal of, and un-realised gains resulting from the holding of non-current assets, e.g., fixed assets;

(b) Un-realised holding gains resulting from the change in value of current assets, and the natural increase in the herds and agricultural and forest products;

(c) Realised or un-realised gains resulting from changes in foreign exchange rates and adjustments arising on the translation of foreign currency financial statements;

(d) Realised gains resulting from the discharge of an obligation at less than its carrying amount;

(e) Un-realised gains resulting from the restatement of the carrying amount of an obligation.

Thus, revenue does not include all recognised increases in assets or decreases in liabilities. Receipts of the proceeds of a cash sale is revenue under generally accepted accounting principles because the net result of the sale is a change in owners’ equity.

On the other hand, receipts of proceeds of a loan, investment by owners or receipt of an asset purchased for cash, income on investments, gains on the sale of fixed assets are not revenues, as per the accounting standard issued by the ICAI.

The second narrower interpretation of revenues is more appropriate and useful to the external user and other decision-makers as revenues are defined in terms of primary activities and operations of a firm which are truly income-generating business activities. In spite of the distinction between revenues and gains, both are included in the income of a business enterprise.

Activities that Produce Revenue:

As stated earlier, revenues arise only from those activities that are designated business operations. These activities are known as earning process or operating cycle of a business enterprise, especially in a manufacturing concern. These activities undertaken by the firm together make a profit and include a fairly long chain of events.

In the earning process or operating cycle of a manufacturing concern, the following six critical events (activities) are generally found:

(1) Acquisition of resources.

(2) Receipt of customer orders.

(3) Production.

(4) Delivery of goods or performance of services.

(5) Collection of cash.

It may be mentioned that each of the above critical events is a productive activity, that adds value in some measure to the goods or merchandise purchased. On these grounds, a portion of the ultimate sale price ought to be recognised as revenue as each activity is performed.

The difficulty is that the ultimate sale price is the joint product of all activities, and it is impossible to say with certainty how much is attributable to any one of them. For this reason, in accounting, revenue is recognised at a single point in this earning process or operating cycle.

The main reasons for choosing a single point or event or activity and not measuring the separate profit contribution of each activity is to have greater objectivity in revenue and income measurement. Obviously, profit cannot be objectively measured at each step of the operating cycle.

Revenues, in most cases, are the joint result of many profit-directed activities (events) of an enterprises and revenue is often described as being earned gradually and continuously by the whole of enterprise activities.

Earnings in this sense is a technical term that refers to the activities that gave rise to the revenue—purchasing, manufacturing, selling, rendering service, delivering goods, the occurrence of an event specified in a contract and so forth. All of the profit-directed activities of an enterprise that comprise the process by which revenue is earned is, therefore, rightly called the earning process.

Figure 5.1 illustrates the above activities, constituting the operating cycle or earning process of a typical manufacturing concern.