The realization concept is the basis on which revenue and other income are recognized in the financial statements. If there is no IFRS that handles a particular revenue transaction, this principle can be used to post into the book of accounts by accountants.
Realization concept defined
The principle states that revenue is recognized when they are earned. Income is earned when the risks and rewards attached to the product or services have passed, it doesn't matter if there is a payment for it or not. However, deciding when revenue is received can be based on industrial norms. That is, when companies in the industry are in harmony on when revenue is earned.
Revenue is recognized when it is cancelled, measured objectively, and the amount receivable from the sale is certain. For example, a client orders a special cake according to his specifications. Therefore, the company will have to objectively decide on the price of the cake rather than using the general pricing it used for its regular sales.
IFRS 15 explains how revenue should be recognized in the financial statements. It focuses more on goods and services businesses including warranty and construction businesses. A five-step model was introduced in the IFRS standards as a criterion in deciding when revenue should be recognized in the books.
Other standards deal with other issues like lease revenue. When there are no accounting standards that handle how revenue is recognized the realization principle can be used as an alternative way to understand when to recognize it.
Realization, matching, and accrual concepts
The matching concept explained that expenses for the period must be matched with their revenue. The concept is about ensuring that the revenue for that month is recorded for the period along with the expenses of the same period. This implies that there shouldn't be any mismatches. That is, recognizing revenue for a different period in the current period.
Realization concept, however, explains the measurement of revenue and how it is recognized in the financial statements. And it focuses on revenue rather than expenses. Therefore, the realization principle is different from the matching concept.
The accrual concept clearly states that revenue is recognized when they are earned and expenses when they are incurred rather than when they are received or paid.
In summary, the realization concept is applied when no IFRS standard covers the treatment of revenue of a company. It sets the criteria for recognizing revenue of an entity. It is different from the matching concept and an aspect of the accrual principle.