Revenue Recognition Principle

Introduction

It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles (GAAP) or alternatively International financial reporting standards (IFRS). The primitive requirement of the principle is that following the accrual concept in relation to the accounting of the transactions, Revenue should only qualify for recognition when there is substantial evidence with regard to the completion of the revenue cycle. Stated differently, record the revenue transaction, when there is reliable evidence that it is earned.

Example of the Revenue Recognition Principle

ABC is an organization that principally deals in relation to the snow plowing services. The company has completed the services in relation to the plowing of XYZ organization’s parking space. The standard charges for the service are $100. The revenue transaction can be recorded right after the rendering of the services of the plowing, though there is no expectation with regard to the payment from the intended customer for several further weeks. This is how revenue recognition principle functions under the accrual basis of accounting.

Revenue Recognition Principle and advance payment

Suppose that the XYZ organization pays $1,000 in advance in relation to the acquisition of the snow plowing services for the subsequent six months. In such case, there will be a recording of the incremental revenue in each month for which services are rendered. In this case, each month $166 amount of the revenue is recognized and an adjusting entry is passed to bring down the balance of the advance payment. In this way, revenue is accurately reflected for the entire period of the agreement that is six months in the subject case. The advance payment that is $1000 is not revenue for the ABC organization but a liability which will be settled down by the rendering of the services. This is why it is classified as current liability section in the Balance sheet unless it is completely set off by the corresponding adjusting entries to the revenue account.

Revenue Recognition Principle and Cash basis of Accounting

Revenue recognition principle is quite simple when the organization used the cash basis of accounting for the preparation of its financial statements. Cash basis of accounting requires that the organization should recognize revenue right at the point of receiving the payment irrespective of the fact that it relates to the service rendered in the prior periods or will be rendered in the future period(s).

Revenue Recognition Principle and IFRS

Revenue recognition is an important aspect of the financial reporting process of the organization. This is why it is subjected to excessive controls, so that risk of fraudulent financial reporting in revenue cycle is minimized. Over and above, Auditors also deem it as a risky area of the financial statements which may consist of misstatements. This is why Auditors apply extensive procedures on the Revenue to verify it. IFRS has also strongly emphasized the fair recording of the revenue and for this purpose issued a dedicated revenue standard to achieve the objective of fairness of revenue reporting.

Conclusion

The primitive requirement of the principle is that following the accrual concept in relation to the accounting of the transactions, Revenue should only qualify for recognition when there is substantial evidence with regard to the completion of the revenue cycle. Revenue recognition is an important aspect of the financial reporting process of the organization. This is why it is subjected to excessive controls, so that risk of fraudulent financial reporting in revenue cycle is minimized.

Reliability Principle

Introduction

It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles or alternatively International financial reporting standards. Lets brief it a little using the real time examples. Suppose that you have purchased certain cosmetics from a departmental store and subsequent to your purchases you are handed in a cash memo detailing your purchases quantity, rate, the value of each item and the total bill. This cash memo serves as the source document for the accountants and it is sufficient and objective evidence underlying the specific record of the transaction.

Reliability principle opines that only those transactions should become part of your accounting information system that are supported by an objective commercial document such as cash memo in the above case.

Examples of Objective Documents in relation to Reliability Receipts

Following documents serve as objective and appropriate documents and support the transactions recorded on the basis of them:

1.      Purchase Receipts It is issued subsequent to any specific purchase that relates to either goods or services. The seller issues the same to the buyer.

2.      Checks or canceled checks They serve as evidence in relation to journal entries which involve banks. In the case of receipt or issuance of a check, the bank is debited or credited respectively. Canceled checks serve as evidence of reversal entries involving bank accounts.

3.      Bank Statements Bank statement serve as evidence and support the closing balance of the specific bank account that is reported under the current asset section of the Balance Sheet.

4.      Promissory Notes Promissory notes serve as appropriate evidence in relation to any specific account payable balance at the reporting date.

Auditors and Reliability Principle

Auditors seek audit evidence before they can opine about the fairness of the financial reporting practices of the specific organization. Source documents discussed as above serve as appropriate audit evidence for them which assists them concluding as a whole about the fairness of the financial reporting system of the organization.

Documents that are more Reliable

Usually, the commercial documents that are internally generated are not considered as good evidence of the transactions. The commercial documents that are issued by the third parties serve as good and objective evidence of the accounting transactions used to be recorded. A perfect example of the third party evidence is Bank statement. Bank statement serves as evidence and supports the closing balance of the specific bank account that is reported under the current asset section of the Balance Sheet. It is acceptable by the auditor as evidence in relation to specific bank account balance which is reported by the management in the notes to the financial statements.

IFRS and the principle of Reliability

IFRS is a globally implemented financial reporting framework. IFRS requires that only those transaction should become part of the financial statements which can be measured reliably to sufficient extent.  This is source documents or the third party evidence which IFRS is talking about and hence assists in the reliable measurement of the transactions.

Conclusion

Reliability principle opines that only those transactions should become part of your accounting information system that are supported by an objective commercial document. Auditors seek audit evidence before they can opine about the fairness of the financial reporting practices of the specific organization. Reliability principle significantly assists them in the audit of the financial statements of the organization and this way these audited financial statements serve as a benchmark for the decision making of the stakeholders.

Matching Concept

Introduction

It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles or alternatively International financial reporting standards. Think for a moment if it appropriate that you match the revenues in relation to the specific period of time with the expenses that related to another period. Such profit figure is not true and does not demonstrate the true picture of the financial operations.

The literal meaning of the word matching is to make sure that two things are corresponding, equal or equivalent in certain characteristic. Likewise, in the accounting language, the matching concept requires to match and compare the revenues and expenses that relate to the same period. This way it enhances the qualitative characteristics of the financial statements that is comparability and understanding and helps the organization to demonstrate the true picture of the profitability of the operations of the organization. In this way, the stakeholders of the organization that is the investors, creditors, employees and others can make informed decisions.

Explanation

The matching concept is particularly applied in relation to the accrual principle. The accrual principle requires the accountants to recognize the gains and the expense of the specific organization keeping in consideration the actual occurrence of the transactions and ignoring the actual receipt or payments of the cash flows. In this way, the revenues and the expense of the particular period are compared and it manifests the real picture of the profitability in relation to the organization.

Auditor and the Matching Concept

Auditors have quite procedures that can demonstrate and establish that the matching concept is applied. For instance, they used to perform cash count and stock count at the end of the period and this ensures that the figure cash and the stock are correctly reported at the end of the reporting date and the corresponding figures of payments and the stock consumption are truly representative of the accounting period covered up to the end reporting date. The further payments or consumption of the sock will not be recognized in the current period accounts.

Cash basis of accounting and the Matching concept

Cash basis of accounting is opposite to not only the accrual basis of accounting but the matching concept as well. In the cash basis of accounting all the receipt or the payments in relation to the cash flows with regard to the certain accounting period irrespective of the fact that receipt or the payment of the cash flow is in relation to the revenue and expense of this period, prior period or any subsequent period and this way the receipt and payment account is not truly the representative of the financial operations of the organization.

Conclusion

In the nutshell, matching concept requires to match and compare the revenues and expenses that relate to the same period. This way it enhances the qualitative characteristics of the financial statements that is comparability and understanding and helps the organization to demonstrate the true picture of the profitability of the operations of the organization. In this way, the stakeholders of the organization that is the investors, creditors, employees and others can make informed decisions. The matching concept is particularly applied in relation to the accrual basis of the preparation of the accounts.

Marginal Costing

Marginal Costing

Primitive characteristic of the Marginal costing is that it revolves around the variable cost of the eventual produce of the entity. Break-even is the technique that is used quite frequently in relation to the marginal costing because it also makes use of the variable costs. The contribution margin which is the yield in relation to each of the production line is the basic foundation for assessing the profitability of the specific organization or the specific department of the same organization. Marginal costing is the basis and primary technique in relation to the valuation of the finished goods stock or alternatively the work in process. Keep in mind that the work in process is that inventory which is not completely manufactured and requires more time and cost for the finalization.

In the marginal costing, the variable cost is usually used for the analysis and computation. It is, therefore, pertinent that any cost that is semi-fixed in terms of nature be bifurcated in either the variable or the fixed expenses thereby making the analysis and computation more reliable for the decision-makers.

Basic Idea Underlying the Marginal Costing Approach

The marginal cost is essentially referred to as the variable costs because the marginal costs change with the changes to the production quantum. Likewise, variable costs change with the modification to the production quantum schedule. In relation to any production, the cost using the marginal costing approach can be computed easily by taking the sum of the direct materials and the costs in relation to the direct labor. Similarly, such expenses that can be readily identifiable and traceable in the product are also included. All the aforementioned direct costs have a direct relationship with the quantum and threshold of the sales and production and any change to the same will for surely influence the cost of the product using the marginal costing approach. 

Fixed costs are those costs in which there is no variation no matter what is the production quantum.  The marginal costing is very useful for the internal stakeholders as it assists the internal decision makers in identifying the cost in relation to a single unit of production that can be saved provided it is not manufactured or will be expended provided the decision makers go in favor of further production.

Variable Costs as the Costs of the Product

In the marginal costing, the incurred variable costs in relation to the production are essentially made part of the unit product cost and on the other hand, the fixed cost used to be subtracted from the computed contribution margin of the company. In this way, variable costs are made the part of the final product cost and the fixed cost is reported as the period costs. Contribution margin is the central concept in relation to the marginal costing and is demonstrated by the following relation that is Contribution margin = the excess of sales over the incurred variable costs.

Variable Cost and the Decision-making

It is pertinent to note that the management accountant makes frequent use of the marginal costing in relation to the decision making. The rationale is that by using marginal costing approach the decision makers identify and visualize the actual impact of the decision and how it impacts and adapts the eventual costs involved.

Conclusion

Primitive characteristic of the Marginal costing is that it revolves around the variable cost of the eventual produce of the entity. Break-even is the technique that is used quite frequently in relation to the marginal costing because it also makes use of the variable costs. In the marginal costing, the incurred variable costs in relation to the production are essentially made part of the unit product cost and on the other hand, the fixed cost used to be subtracted from the computed contribution margin of the company. In this way, variable costs are made the part of the final product cost and the fixed cost is reported as the period costs.

Going Concern Principle

Introduction

It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles or alternatively International financial reporting standards. The principle feature in relation to the going concern principle is that it establishes the perception of continuation of the operations of the organization with regard to the foreseeable future. Think for the moment if there is no such perception, would you go for investing in such organization? Definitely, there would be a big No. The non-compliance to the going concern principle has far-reaching implications for the organization.

Implications in case of absence of the Going concern

If you have a little experience of observing the annual report of any public company you would definitely observe a set pattern in relation to the preparation and presentation of the financial statements. This set pattern is valid only in the case when the going concern principle is valid for the specific organization. If there is the absence of the going concern principle in relation to the specific organization, then the preparation of the financial statements is not same as you have observed by accessing an annual report of the certain public company.

Liquidity order if Going concern holds no more

The financial statements of the concern for which going concern assumption does not hold anymore used to be prepared on the liquidation basis. For instance, in relation to the Balance sheet prepared in accordance with the liquidity order, cash is presented first, followed by such securities that have short-term maturities that is marketable securities. Subsequent to the cash and marketable securities, we will present accounts receivable and the inventory would be presented in last.

Adjustments to the carrying values Recognized in the financial statements

It is important to consider that when the going concern assumption holds no more, we have to write down the values of the assets, liabilities and the equity. Usually, the written down value to comply with the liquidation process are less than the carrying values already reported in the balance sheet. 

Auditor and the Going Concern Principle

Auditors have precise focus if the going concern assumption holds true for the organization or not. They have designed procedures to establish the going concern of the specific organization. The reporting frameworks that is international financial reporting standards and GAAP do not discuss going concern much, however, they require the auditors to verify and establish if the going concern holds true or not. In the case, going concern does not hold true it will eventually result in the qualification of the financial statements.

There are indicators which may point out about the going concern assumption not holding for the specific organization. For instance, negative trends in relation to the operational activities and results and likewise there are numerous discontinued operations and product lines. Moreover, repeated loan restructuring or not complying with the loan repayment schedules can be another instance of the absence of the going concern.

Conclusion

The principle feature in relation to the going concern principle is that it establishes the perception of continuation of the operations of the organization with regard to the foreseeable future. If there is the absence of the going concern principle in relation to the specific organization, then the preparation of the financial statements is not same as you have observed by accessing an annual report of the certain public company. The financial statements are usually prepared on the liquidity basis and it implies that the organization is not able to operate in the long-term.

Full Disclosure Principle

Introduction

You would have gone through the article named materiality principle whose principle requirement is that there should be no omission or misstatement in relation to the information in the financial statements that could have potential influence over the decision-making process of the stakeholders. The information may be financial information or alternatively non-financial information. In either case, it is certainly going to hit the process of decision making on the part of the stakeholders.

 It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles or alternatively International financial reporting standards. The compliance with this accounting principle would result in the financial statements that have enhanced qualitative characteristics that are understanding, completeness, and comparability. International financial reporting standards have required the management of the organizations to comply and report the disclosures to enable the user to be more informed about the financial operations of the organization.

Example of the Disclosures required by IFRS

Some of the instances that require proper and full disclosures are changing the accounting policy, relationships maintained with the related parties and transactions with the same. Disclosures are not always financial, at times, non-financial disclosures are mandatory as well. For instance, it is quite possible that there are related parties, however, there are no transactions with them over the whole of the reporting period. IFRS still require the disclosure of the same and it would be a non-financial information disclosure. Change in accounting policy may impact financial statements in monetary terms and the disclosure of the same would be a financial disclosure.

Full Disclosure Principle and Notes to the Financial Statements

In the article, components of the financial statements, we developed our know-how in relation to the notes to the financial statements. The full disclosure principle has real-time application for that component of the financial statements. It is important to recognize that not all the disclosures mentioned in the International financial reporting standards and GAAP are usually presented by the management in the financial statements. The rationale behind is practicability. The circumstances used to vary from organization to organization. In the financial statements of the organization, only such notes are prepared as per the full disclosure principle which are material in terms of nature as well as financial impact. This would reduce the quantum of the notes to the financial statements in addition to controlling the cost of presenting such notes which go quite well with the cost-benefit analysis to a significant extent.

Conclusion

Full disclosure principle is the real time application of the materiality principle. The compliance with this accounting principle would result in the financial statements that have enhanced qualitative characteristics that are understanding, completeness, and comparability. International financial reporting standards have required the management of the organizations to comply and report the disclosures to enable the user to be more informed about the financial operations of the organization. Preparing and presenting the disclosures to enable the user to make effective decision making is quite important from the corporate governance point of view as it assists in the strengthening of the controls in the organization which leads to increased profitability and sustainability.

Cost Principle

Introduction

It is one of the important accounting principles and is the basis of many accounting requirements set out in either of generally accepted accounting principles or alternatively International financial reporting standards. The cost principle requires that the elements of the financial statements that is assets, liabilities or the investments should be reported and valued at the historical cost at the time of their acquisition and recognition. In the recent developments of the accounting standards, cost principle has been significantly replaced by the fair value.

Explanation

The application of the cost principle can be effectively observed in relation to the acquisition of the certain plant asset. The asset would be recognized at the outright purchase price in the books of the organization. This is referred to as the cost model in the international accounting standard # 16. Let’s say the asset has the useful life of the 10 years and the organization finds it reasonable to depreciate the same using the straight-line depreciation method. In the absence of the salvage value, the outright purchase price would be depreciated over the 10 years time period.

Adjustments to the Cost

The cost that would be capitalized increases if the plant asset has appeals non-refundable taxes and duties in addition to the handling and installation charges. The cost principle requires to include all such costs in the cost of the asset being acquired. When the cost is adjusted for the duties and costs, the depreciable amount is again computed by subtracting the salvage from the total cost recognized. The depreciation expense would then be computed as per the management policy of recongisation of the depreciation expense. The opposite to the cost principle (cost model) is the revaluation model which requires the specific plant asset to be checked if there is an increase in its value as a result of the active market.

Intangible assets and the cost principle

The international financial reporting standards require that brand names that are acquired and purchased can be recognized at the cost likewise the plant assets however the brand names that are internally generated cannot be recognized as such.

When It is appropriate to switch to the Fair value

There must be active market along with the quotes prices for the asset that is considered for the option of valuing on the fair value. For example, the equity investment of the company that comprises of the shares that have active trading on the recognized stock exchange market. In such a case, it is appropriate to value the investment at the fair value instead of the historical cost and the cost principle may be departed.

Conclusion

The cost principle requires that the elements of the financial statements that is assets, liabilities or the investments should be reported and valued at the historical cost at the time of their acquisition and recognition. In the recent developments of the accounting standards, cost principle has been significantly replaced by the fair value. The application of the cost principle can be effectively observed in relation to the acquisition of the certain plant assets as well as the brand names and other intangible assets. When any asset has an active market, it is  a  approach to switch to the fair value model from the cost principle model.