3 principles for understanding how revenues & expenses are reported in financial statements Flashcards
Accrual Method
A way of recognizing revenues and expenses when they are earned or incurred, regardless of when the payment is made or received.
In Accrual Accounting, the Revenue Recognition Principle tells us____?
When to record revenue.
The matching principle ensures_____?
That expenses are recorded in the same period as the related revenue.
Who commonly uses the Accrual Method?
Larger companies or those with more complex financial operations
Why do larger companies or those with more complex financial operations use the Accrual Method?
o This method provides a more accurate picture of a business’s financial condition compared to the cash-basis method.
o It is essential for businesses that offer credit terms to customers, maintain an inventory, or deal with prepaid expenses.
When should a business record Revenue? (Revenue Recognition Principle)
It states that revenue should be recorded when a business provides a product or service to a customer, regardless of when the payment is received.
Revenue Recognition Principle
o It states that revenue should be recorded when a business provides a product or service to a customer, regardless of when the payment is received.
o On the other hand, when a business receives payment in advance, known as deferred revenue or unearned revenue, the revenue recognition principle states that this revenue cannot be recognized until the service is completed.
The revenue recognition principle states that _____?
Revenue cannot be recognized until the service is completed.
When a business receives payment in advance, it is called?
deferred revenue or unearned revenue
Expenses are recorded in the same period as the related revenue, uses which Principle?
The matching principle ensures that expenses are recorded in the same period as the related revenue.
Matching Principle example?
Your client incurs an expense that is related to revenue generated in a different month, they should report the expense in the same month as the associated income to accurately match the timing of expenses with revenue. This way, they can accurately calculate the actual profit.
(Example: Client rents a truck in April for a job in May, and their client pays them in June. In this case, both the truck expense and the job revenue should be reported in the May report. By following the matching principle, your client can accurately represent their profitability and understand which clients or projects are profitable. It also helps with managing cash flow effectively and ensures accurate financial reporting.)
