Question

what are the implications of inventory costing, contingent liabilities, and revenue recognition with regards to a opening a new business.

Answer 1

1. Inventory costing - A new business will have to decide on which method of inventory costing it will have to use. There are four methods of costing inventory items. They are FIFO (first in first out), LIFO (last in first out), weighted average and specific identification. A company must decide on which method of inventory to use keeping in mind its business and economic scenario. If prices are rising then use of LIFO method will lead to lower taxes. This is because its cost of goods sold will consist of latest inventories that are priced higher due to rising prices. Thus a new business should decide on which method of inventory costing should it use keeping in mind its business and economic scenario.

2. Contingent liabilities – Contingent liabilities are potential liabilities that may arise depending on the outcome of a future event that remains uncertain. A new business will have to determine if its contingent liabilities are probable and its amount can be estimated or if the liability is possible but not probable. If the contingent liability is both probable and the amount can be estimated then the new business will have to record the amount with a journal entry. However if the contingent liability is only possible and not probable then a new business will just have to provide a disclosure. In cases where contingent liabilities are remote then no journal entry and no disclosure will be required.

3. Revenue recognition – As per the GAAP (generally accepted accounting principles) revenue should be recognized on the occurrence of a critical event and when the amount of revenue is measurable. A new business should ensure that it recognizes revenue when it is realized and earned, and not generally or necessarily when it is received.

A new business may follow an accrual basis of accounting or a cash basis of accounting. If the new business has an accrual basis of accounting then it will record revenue only when the revenue generation process is completed and revenue has been earned (not necessarily received). If the new business has a cash basis of accounting then it will record its revenue only when cash payment has been received by the new business.