Milton L. Jones Jr., Michelle Evans, Sarah Ricard, Kirk Murray
November 17th, 2014
Working with Financial Statements
Accounting concepts are numerous in amounts. They set the ground rules to follow in preparing accounts and financial statements. Financial statements provide knowledge of the financial health of companies. Companies have to learn about different financial statements and their uses to be successful and stay competitive with other companies. Through financial statements, companies, investors, creditors and small business owners can analyze risks, health and profit.
Revenue Expense Principle
The revenue recognition principle applies when using accrual based accounting. You record revenue when it has been earned and not necessarily received. An example of this would be a landscaping company that completes services at a job for a fee of $1,200. Using the recognition principle, the revenue can be immediately recognized upon the completion of the job, even if it does not receive payment from the customer for several weeks. Another example could be that the company receives a deposit of $1000 in advance to service a customer on a six month basis. In this scenario, the service should recognize an increment of the advanced payment in each of the six months covered by the service contract. This will reflect the pace in which the payment was earned. Also under the rules if accrual based accounting, if a company receives payment in advance from a client, then the records should reflect this payment as a liability and not as revenue. It can only be counted as revenue once the services are rendered and the payment is earned.
Expense Recognition Principle
Expense recognition principle states that revenue is recognized only when the rewards or benefits associated with the services rendered or an item sold is transferred. In accrual based accounting it is the matching principle to revenue recognition. All costs that were incurred to generate revenue appearing on any given months income statement should appear as an expense on the same statement. This is real time accounting. The expenses should match against the revenues earned. This helps company leaders and investors to see both revenue and expenses to evaluate true performance of the company. The matching principal is implemented in one of three ways. The first is associating cause and effect. An example of this would be cost of goods sold at a car dealership versus the salesman’s commissions. The commission expense is directly tied to the revenue generated. There is systematic and rational allocation. Some costs cannot be directly linked to a specific revenue transaction. An example of this would be depreciation of the building at the car dealership. Then there is immediate recognition. Examples of this would be utilities, staff salaries, interest on outstanding mortgage note on the commercial building, etc
The four situations that require journal entries are prepaid expenses, unearned revenue, accrued expenses and accrued revenue. To understand this, we must look at what an adjustment journal entry is. It is when a company records a transaction of revenue or an expense during an accounting period. It could be the company getting paid or paying a creditor or an expense account during the accounting period. Therefore, let’s say you walk into Macy’s department store and purchase a diamond Ring with a credit card, it would record a revenue recognition principle that you intend to pay for the merchandise. In that accounting period, Macy's will create an adjustment journal entry for that promissory sale and give you the Ring, and then billed the credit card company for the purchase.
Even though you got the diamond ring from Macy's, and they recorded that transaction as a sale on that particular date, Macy's didn't get paid on that date. Therefore when Macy's request for payment it is honored by the credit