Question

A new client, the Wolf Company, asks your advice concerning the point in time that the company should recognize revenue from the rental of its office buildings under generally accepted accounting principles. Renters usually pay rent on a quarterly basis at the beginning of the quarter. The owners contend that the critical event that motivates revenue recognition should be the date the cash is received from renters. After all, the money is in hand and is very seldom returned. 

 

Required: 

Do you agree or disagree with the position of the owners of Wolf Company? State whether you agree or disagree, and support your answer by relating it to accrual accounting under GAAP.

Answer 1

Revenue Recognition Principle

In order to present a true and fair financial position every year, entities ought to adopt the revenue recognition concept. It is based on the foundation of the accrual method of accounting and supplements the matching principle. Revenues are recorded as and when they are earned and not when the cash is actually received. With the constantly evolving business environment and increasing complexities in transactions involved, the necessity to adopt the accrual method was felt. That is when almost every major economy and statutory body, laid the framework for a systematic inclusion of accrual accounting as well as the revenue recognition concept which eventually proved to be fruitful for the external users of financial information and the management as well.

 

I disagree with the position of the owners of Wolf Company as according to the accrual concept under GAAP, revenue should only be recognized when the earnings process is believed to be complete, and there should be a firm conviction that the revenues will be received in the future. In the above scenario, as the earnings process is still incomplete, it is wrong for the management to recognize the rental income.

Revenue Recognition Principle

In order to present a true and fair financial position every year, entities ought to adopt the revenue recognition concept.