Question

Under the accrual basis accounting, revenues and expenses are recognized by the following principles:

• Revenue recognition: Revenue is recognized when both of the following conditions are met: Revenue is earned and Revenue is realized or realizable.
• Expense recognition: Expense is recognized in the period in which related revenue is recognized (this is also known as the Matching Principle).

Respond to the following in a minimum of 175 words:

• Discuss when the requirements of the revenue recognition principle are usually met. Give an example.
• Discuss when the requirements of the expense recognition principle are usually met. Give an example.

Answer 1

Revenue recognition principle :

The revenue recognition principle states that revenue should be recognized and recorded when it is realized or realizable and when it is earned. In other words, companies shouldn’t wait until revenue is actually collected to record it in their books. Revenue should be recorded when the business has earned the revenue.

For revenue to be recognized, the following conditions must be met:

1. Risks and rewards of ownership have been transferred from the seller to the buyer.
2. The seller does not have control any longer over the goods sold.
3. The collection of payment from goods or services is reasonably assured.
4. The amount of revenue can be reasonably measured.
5. Costs of revenue can be reasonably measured.

For example, a snow plowing service completes the plowing of a company's parking lot for its standard fee of $100. It can recognize the revenue immediately upon completion of the plowing, even if it does not expect payment from the customer for several weeks.

Expense recognition principle :

The expense recognition principle states that expenses should be recognized in the same period as the revenues to which they relate. If this were not the case, expenses would likely be recognized as incurred, which might predate or follow the period in which the related amount of revenue is recognized.

For example, a business pays $100,000 for merchandise, which it sells in the following month for $150,000. Under the expense recognition principle, the $100,000 cost should not be recognized as expense until the following month, when the related revenue is also recognized. Otherwise, expenses will be overstated by $100,000 in the current month, and understated by $100,000 in the following month.