When Is A Sale Really A Sale?

“In accounting terms, the sale is only a sale at the point in time that it hits the profit and loss account. It’s really important to recognise that not every activity we do can truly be recognised as a sale and if we get that wrong we’re going to make some decisions based on incorrect data and those decisions will therefore be quite negative.

We have to look at the concept of revenue recognition in order to recognise when a sale is really a sale. Revenue is just another word for sale and revenue recognition is understanding the point in time that a sale can actually be recognised. We have to look at the risks and rewards of transferring that product or service to our customer. Let’s just look at this simple example:

Simple Example:

If we’re selling secondhand cars, we’ve sold that car, the customer drives that car away. We can clearly see that the risks and rewards have transferred to the customer at that point in time.

Some of the risks would be that the customers have got to pay for their own maintenance, they’ve got to pay for the running costs of the car and of course, the rewards would be that they’re enjoying using that car. Nice, simple and straightforward. Customer drives the car away and we know we’ve made that sale happen.

Complex Example:

It can be more complex in some industries. For example, if you wanted to buy an airline ticket, you’re going to travel perhaps a few months later down the line, but you’re going to hand over your cash to the airline at the point that you buy that ticket. The airline is going to gladly receive your cash but at that point in time all they’ve sold you is a promise. They haven’t sold you a product or service until the point that they actually operate the flight that you’ve paid for. In the meantime, they have to hold that sale within their balance sheet, under a category called deferred income and only at the point that they provide the service that you have paid for, providing that flight, that’s when they will recognise the sale has happened. That’s when the risks and rewards have been transferred.

In accounting terms, we can only recognise the sale has happened at the point in time that we transfer the risks and rewards of the product or the service that we’re providing to our customer.”