Question

Explain the revenue and expense recognition principles with an example. Within this respect, explain aslo why unearned revenues cannot be revenues but liabilities.

Answer 1

Answer)

Priniciples of revenue and expenses recognition:

1)Accrual basis:

Under this principle the revenue is tend to be earned as soon as goods are delivered or services are performed without taking into the account whether cash is Received or not.

Eg: Mr.X sold goods for $300 for Mr.Y on credit.Here,the revenue is recognised as soon as goods transfer is considered.

Expenses under accrual basis is realised in the period in which revenue for that incurred expenses is earned.

Eg:In above example,the cost of goods sold is $200.Here, Mr.X considers realises such expenses even such goods sold are purchased by Mr.X on credit.

Cash basis Priniciple:

Under this priniciple,the revenue is recognised only when cash is received.

Eg:Mr.X sold goods to Mr.Y for $300.Here,the revenue is recognised by Mr.X only when Mr.Y pays the cash.

Under this priniciple,the expenditure is recognised as paid only when it is paid.

Eg:In above example,If Mr.X need to pay $20 for goods distribution then such expense is realised only when $20 is paid.

An unearned revenue is considered to be a laibility because the persons who received such revenue still didn't repay for such amount where such repayment may be either in cash or in goods or services.