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What is operating revenue in accounting? How the operating revenue is recognised, measured and presented within the financial statements, and what are the main accounting journals when accounting for sales or other operating inflows.

What is operating revenue in accounting? How is the operating revenue recognised, measured and presented within the financial statements, and what are the main accounting journals when accounting for sales or other operating inflows.

While a company can have many steams of income that generate operating and non-operating revenue from different business activities the company is conducted, the operating revenue represent the processed a company generate from the company primary business activity.

As an example, a retail company will generate the operating revenue from the sales of goods but could generate non-operating revenue from other sources as interest received, proceeds from sales of assets or other activities outside of the company primary operations.

Operating revenue is an important metric in measuring a company productivity and profitability from its core activity and an important tool for analysing and evaluating a company health and prospects that could be expected from the business activity in the future.

While operating revenue must be presented separately form the non-operating revenue on the company financial statement some companies could attempt to influence the decrease in operating revenue and could merge the operating and non-operating revenue. For this reason, the readers of financial statement must be careful and get enough information to distinguish the sources of revenue when analysing the company financials.

Revenue means the amounts a company receive from all streams of income. Subsequently based on the type of income the amount received are recorded within the company books of accounting into operating revenue or non-operating revenue that are described below:

Operating revenue represent the proceeds a company receive from the core business activity. As an example, a company selling shoes as a main activity will classify the income generated from the sales of shoes as operating revenue. 

Non-operating revenue represent the proceeds received from non-core activities of a company. Following the example below we have said that a company selling shoes as a main activity will classify the income generated from the sales of shoes as operating revenue, whereas if a company have some of the profits invested in stocks, bonds, sale of assets or other non-core business activities the interest, dividends or proceeds received should be classified as non-operating revenue.

There are many fields of actives where the companies operate, and the operating revenue represent the income generated from the main field of activity a company is operating. The main types of operating revenue are the sales of goods, sale of services, licensing or membership as described below:

There are many fields of activities that can generate operating revenue for the company from the sales of goods. Either it is a retail shop, or a production and distribution acting within the fashion, food or other industries the income generated from the sales of goods resulted from the company primary business activity will be recorded and presented within the company financial statements as operating revenue from sale of goods.

The services industry is in very demand these days and companies can be specialized and offer as a primary activity serviced in many services sectors as finance, education, consulting and so on.

The companies in service sector that have as a primary activity the sales of services will recognise withing the financial statements the proceeds obtained from offering services as operating revenue from sale of services.

Companies that developed new technologies, have a reputation and strong brand within the market, or own other forms of intellectual property can give the rights for use of them technologies, brand, trademark or other intellectual property to other business partners in exchange for a licence fee.

When a company have as a main source of income the proceeds generate from licensing will recognize, record and present the income on the financial statements as operating revenue from licensing.

Companies offering then service or access to products in form of membership and the mainstream of income is the money generated by offering membership subscriptions will recognize, record and present the income on the financial statements as operating revenue from membership.

Some examples of entities that use the membership model can be professional associations, sport clubs, foundations, charities etc.

Firstly, we need to look at company total revenue that include all income generated by a company from operating and other non-operating business activities. Operating revenue represent the income generated from the company primary activities and will be recognised, recorded and presented separated from the non-operating revenue on the company books of accounting and financial statements.

Operating revenue can arise from the sales of goods, services, or other streams of income generated from company primary activity and will firstly be recorded on the company Statement of Income (Profit & Loss) by crediting the operating revenue and on the other side debiting the cash or debtors (receivables) as you can see in the accounting journal below:

Double entry accounting journals for recording cash sale of products.

  • Credit (CR): Income Statement (Profit & Loss) – Operating Revenue from Sale of Products
  • Debit (DR): Income Statement (Profit & Loss) – Cost of Product Sales

Double entry accounting journals for recording cash sale of services.

  • Credit (CR): Income Statement (Profit & Loss) – Operating Revenue from Sale of Services
  • Debit (DR): Statement of Financial Position (Balance Sheet) – Cash

Double entry accounting journals for recording the sale of products on credit.

  • Credit (CR): Income Statement (Profit & Loss) – Operating Revenue from Sale of Products
  • Debit (DR): Income Statement (Profit & Loss) – Cost of Product Sales

Double entry accounting journals for recording the sale of services on credit.

  • Credit (CR): Income Statement (Profit & Loss) – Operating Revenue from Sale of Services
  • Debit (DR: Statement of Financial Position (Balance Sheet) – Accounts Receivable (Debtors) 

Beside Statement of Income (Profit & Loss) the movement in operating revenue will be reflected at the same time on the company Statement of Financial Position (Balance Sheet) and will impact mainly the inventory and accounts receivables (debtors).

The main accounting journals for recoding the operating revenue on the Balance Sheet are outlined below:

Double entry accounting journals for recording cash sale of products.

  • Debit (DR: Statement of Financial Position (Balance Sheet) – Cash
  • Credit (CR): Statement of Financial Position (Balance Sheet) – Inventory

Double entry accounting journals for recording the sale of products on credit.

  • Debit (DR): Statement of Financial Position (Balance Sheet) – Accounts Receivable (Debtors) 
  • Credit (CR): Statement of Financial Position (Balance Sheet) – Inventory

Double entry accounting journals for recording the sale receipts from products sold on credit.

  • Debit (DR: Statement of Financial Position (Balance Sheet) – Cash
  • Credit (CR): Statement of Financial Position (Balance Sheet) – Accounts Receivable (Debtors) 

The Cash Flow Statement of a company is an important part of a company financial statements that show the cash flow movement within a period and is a great source of information for analysing a company financial performance.

The movements resulted from the company sales are an important metric for analysing a company health and are reflected mainly on the income, receivables and inventory, sections of the operating activities of the Cash Flow Statement.

On the income section of the operating activities of the Cash Flow Statement the operating income will be an important part of the total income figure reported on the Cash Flow Statement and for a breakdown the readers of the financials can look at the company Statement of Income (Profit & Loss) and furthermore within the Sales Ledgers

The receivable line on the Cash Flow Statement will show the movement in account receivables from the sales and receipts resulted from the sales on credit. A decrease in accounts receivables could show that the company is more efficient in collecting money from debtors, whereas an increase in accounts receivable will show the company is not enough efficient in collecting money or have given more favourable terms to creditors to boost the sales.

The operating revenue movement have an impact on inventory as well and the movement in inventory is reflected on an inventory line under the section of the operating activities of the Cash Flow Statement.

A decrease in inventory could be interpreted as the company ability to increase the inventory sales movement ratios, whereas an increase in inventory could mean that the company inventory is not moving fast enough, or the company purchase large inventories for get discounts or better terms from the suppliers.

The operating revenue is an important factor for a company to make profits and survive in a competitive market. There are many accounting ratios used to analyse the operating revenue within a company and we will outline the main ones below:

The operating revenue for sales of products is calculated by multiplying the average sales price of product by the number of units sold as per formula below:

Operating Revenue = Average Sales Price of Product x Number of Units Sold

The operating revenue for sales of services is calculated by multiplying the average price of service by the number of customers as per formula below:

Operating Revenue = Average Price of Service x Number of Customers

The operating ration reflect the company ability to generate cost efficiency and is comparing the operating revenue to the product costs as you can se from the formula below:

Operating Ratio = (Operating Expenses + Cost of Goods Sold) ÷ Net Sales

When a company operating ratio is showing an ascendent trend will mean the company operating expenses or costs increase in comparation to the revenue generated. On the other side, when the operating ratio is showing a descendent trend, this will be a good sign as the company is able to reduce the operating expenses or costs in comparation to the revenue generated.

To increase the profitability a company, must look for ways to decrease the expenses or source the goods or materials at lower prices and on the other side to be able to sell them goods or services at a premium. The gross profit margin is comparing the gross profit margins to the company revenue and give an insight of the company efficiency and profitability as per the formula below:

Gross Margin Ratio = (Revenue – COGS) ÷ Revenue

A low gross profit margin will not be a good sign for the company, whereas a high gross profit margin will reflect the company ability to source inventories at lower prices or add value to products in such a way the clients or customers are willing to pay premium price when purchasing the company products.

The main standards that outline the operating revenue are the International Accounting Standards IAS 18 Revenue, International Financial Reporting Standards IFRS 15 — Revenue from Contracts with Customers, and General Accepted Accounting Principles (GAAP) ASC 606.

The International Accounting Standards IAS 18 – Revenue prescribe the accounting requirements for revenue recognition derived from the sale of goods, services, interest received, dividends, memberships, licences, or royalties.

Under the IAS 18 revenue is recognised on the Income Statement (Profit & Loss) when meet the two criteria as below:

  • It is probable that any future economic benefit associated with the revenue stream will flow to the entity.
  • The amount of revenue can be measured with reliability.

The revenue arising from sales of goods is recognised under the IAS 18 when all the five criteria below are meet:

  • It is probable that any future economic benefit associated with the revenue stream will flow to the entity.
  • The amount of revenue can be measured with reliability.
  • The seller has transferred to the buyer the significant risks and rewards of ownership.
  • The seller does not retain managerial involvement and neither effective control over the goods sold.
  • The amount of revenue received can be measured reliably.

The revenue arising from sales of services is recognised under the IAS 18 when all the five criteria below are meet:

  • It is probable that any future economic benefit associated with the revenue stream will flow to the entity.
  • The amount of revenue can be measured with reliability.
  • The stage of completion at the balance sheet date can be measured reliably.
  • The costs incurred, or to be incurred, in respect of the transaction can be measured reliably.

The revenue arising from interest received, dividends, memberships, licences, or royalties is recognised under the IAS 18 when the two criteria below are meet:

  • It is probable that any future economic benefit associated with the revenue stream will flow to the entity.
  • The amount of revenue can be measured with reliability.

International Financial Reporting Standards IFRS 15 — Revenue from Contracts with Customers prescribe the accounting requirements for recognition, measurement and disclosures of revenue arising from contracts with customers. The standard is presented in a five steps model as summarized below:

Step 1: Fists step is the identification of the contract with the customer and must meet the five criteria below:

  • The contract has been approved by the parties, and each party is committed to perform them obligations.
  • The rights of each party in relation to the goods or services to be transferred can be identified.
  • The payment terms for the exchange of goods or services can be identified.
  • The contract has commercial substance by means the contract will be expected to change the cash glow, timing and risk for the company.
  • It is probable that the consideration agreed in return for the goods and services will be received.

Step 2: Second step is the identification of the contract performance obligations and must meet the two criteria below:

  • The goods or services are distinct in relation to other resources that the customer can readily access.
  • The goods or services are distinct from other obligation of the contract.

Step 3: The third step is referring to the determining the transaction price that is the amount expected to be received in return for the goods or services transferred to the customer.

Step 4: The fourth step is to allocate the transaction price to the performance obligations in the contracts. When the stand-alone selling price is not directly observable, the companies can use estimation methods. Some of the methods of estimating the price are listed below:

  • Adjusted market assessment method.
  • Expected cost plus a margin method.
  • Residual method.

Step 5: The fifth and last step is to recognise revenue when (or as) the entity satisfies a performance obligation. Performance obligations are satisfied when a promised good or service is transferred to a customer, that implies that the customer has obtained control of the asset or service.

The General Accepted Accounting Principles (GAAP) ASC 606 outline mainly the revenue recognition, accrual principles and provide a framework of revenue from contracts with customers.

The revenue recognition under the GAAP follows the accrual principles that requires the revenues to be recognized on the Income Statement (Profit & Loss) in the period when the revenue is realized and not only when cash is received.

Under the GAAP there are five steps a company should follow to satisfy the revenue recognition principle:

  • Step 1: The first step is to identify the contract with customer.
  • Step 2: The second step is to identify contractual performance obligations
  • Step 3: The third step is to determine the amount of consideration for the transactions including discounts, returns fees etc.
  • Step 4: The fourth step is to allocate the determined amount of consideration to the contractual obligations per each single obligation.
  • Step 5: The fifth and last step is to recognize revenue when the company receive the consideration in return for the goods or services transferred to the customer.

As we have mentioned above the operating revenue is a key metric for measuring and analysing the business performance. On the other side an important point is the differentiation of operating revenue versus non-operating revenue when reading the financial statement of a company and at the same time when applying ratios to assess the company health.

If you found this article helpful, please go to the rest of the website for more about accounting, or other financial articles about International AccountingAuditTaxationAccounting Software, Cloud Accounting and Accounting Automation.

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The Accounting Journal - A Global Accounting Online Magazine
The Accounting Journal – A Global Accounting Online Magazine
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