Q5. Profit is earned (realized) at the time the goods or services are passed to the customer and the customer incurs liability for them.Explain this statement,
Answers
Explanation:
According to the principle of revenue recognition, revenues are recognized in the period when it is earned (buyer and seller have entered into an agreement to transfer assets) and realized or realizable (cash payment has been received or collection of payment is reasonably assured).
For example, if a company enters into a new trading relationship with a buyer, and it enters into an agreement to sell the buyer some of its goods. The company delivers the products but does not receive payment until 30 days after the delivery. While the company had an agreement with the buyer and followed through on its end of the contract, since there was no pre-existing relationship with the buyer prior to the sale, a conservative accountant might not recognize the revenue from that sale until the company receives payment 30 days later.
Expense Recognition
The assets produced and sold or services rendered to generate revenue also generate related expenses. Accounting standards require that companies using the accrual basis of accounting and match all expenses with their related revenues for the period, so that the income statement shows the revenues earned and expenses incurred in Transactions that result in the recognition of revenue include:
Sales of inventory, which are typically recognized on the date of sale or date of delivery, depending on the shipping terms of the sale
Sales of assets other than inventory, typically recognized at point of sale.
Sales of services rendered, recognized when services are completed and billed.
Revenue from the use of the company’s assets such as interest earned for money loaned out, rent for using fixed assets, and royalties for using intangible assets, such as a licensed trademark. Revenue is recognized due to the passage of time or as assets are used.
The Matching Principle
The matching principle’s main goal is to match revenues and expenses in the correct accounting period. The principle allows a better evaluation of the income statement, which shows the revenues and expenses for an accounting period or how much was spent to earn the period’s revenue. By following the matching principle, businesses reduce confusion from a mismatch in timing between when costs (expenses) are incurred and when revenue is recognized and realized.
Recognition of Revenue at Point of Sale or Delivery
Companies can recognize revenue at point of sale if it is also the date of delivery or if the buyer takes immediate ownership of Goods sold, especially retail goods, typically earn and recognize revenue at point of sale, which can also be the date of delivery if the buyer takes immediate ownership of the merchandise purchased. Since most sales are made using credit rather than cash, the revenue on the sale is still recognized if collection of payment is reasonably assured. The accrual journal entry to record the sale involves a debit to the accounts receivable account and a credit to the sales revenue account; if the sale is for cash, the cash account would be debited instead. The revenue earned will be reported as part of sales revenue in the income statement f
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