Realization refers to inflows of cash or claims to cash like bills receivables, debtors and so forth , arising from the sale of assets or rendering of services. According to realization concept, revenues are usually recognized in the period in which goods were sold to customers or in which services were rendered. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay. To illustrate this point, let us consider the case of A, a manufacturer who produces goods on receipt of orders. When an order is received from B, A starts the process of production and delivers the goods to B when the production is complete. B makes payment on receipt of goods. In this example, the sale will be presumed to have been made not at the time when goods are delivered to A.
A second aspect of the realization concept is that the amount recognized as revenue is the amount that is reasonably certain to be realized. However, lot of reasoning has to be applied to ascertain as to how certain ‘reasonably certain’ is … yet, one thing is clear, that is, the amount of revenue to be recorded may be less than the sales value of the goods sold and services rendered. For e.g. When goods are sold at a discount, revenue is recorded not at the list price but at the amount at which sale is made. Similarly, it is on account of this aspect of the concept that when sales are made on credit, though entry is made for the full amount of sales, the estimated amount of bad debts is treated as an expense and the effect on net income is the same as if the revenue were reported as the amount of sales minus the estimated amount of bad debts.