Recognising Costs and Revenue

Cover by: Getty, as seen on Forbes.com

Section One: Introduction

When keeping accurate accounts of a business's financial position it is important to state any costs and revenues at the correct time, as well as not overstating either. Having a cost recognized too late and revenue too early may place the firms in a position where it no longer goes concern, meaning that it is no longer stable and may no longer exist in the near future. In this article, we will cover some important principles that must be understood when creating financial statements.

Section Two: Subscription Revenues

Subscription services have become more popular with the use of the Internet. Whereas beforehand you could get a monthly magazine thrown at your doorstep, nowadays food deliveries operate on a weekly basis, movies and music are streamed and almost every application on your mobile has a monthly-paid counterpart. For each of those businesses revenue is received in installations. If a business receives a payment on an annual basis, and the product is handed to the buyer monthly, it would be wrong to recognize all of the revenue as soon as the money they paid is received into the firm's account, as the subscription could still be cancelled. For a business like Netflix, it would be important to recognize the credit of cash in monthly instalments even for users on longer subscription periods.

Section Three: When is the Product Provided?

Another important question to be answered is when the product is sold to the buyer. For example, American Airlines has to determine when to recognize the money paid by the consumer, as there are several ways of interpreting when a service is provided. A ticket holder may pay for a flight well in advance, however, it would be incorrect to consider revenue gains when the flight is initially booked. The ticket may be refunded, the flight may be cancelled or in the worst case, the company itself may be non-existent by the time the flight is scheduled. In this case, it is common for airlines and other transport businesses to recognize the gain of revenue only once the flight has safely landed, ensuring correct accounts.

Section Four: Hidden Future Costs?

One more factor to consider in recognizing costs is the costs associated with shutting down a business in the future. In this case, it is common to make an estimate of the expected cost and divide it by how much the business is likely to exist. To illustrate this, we can consider a nuclear power station. Such stations are unlikely to last forever, so there will be costs in the future associated with the demolition and the disassembling of the reactor, so they must be accounted for. Thus, every time an account is filed, a proportion of the future cost is taken into account to ensure that all costs are recognized.

Section Five: Conclusion.

In creating accurate accounts of a firm's financial position it is crucial that prudence is followed. Overstating revenue and understating liabilities and costs could prove fatal for a business, as it leads to instability and critical information failure. Hence, all elements of a financial statement have to be reviewed when a standard for the statement is created and such a standard has to be followed every year to maintain accuracy in comparisons year-on-year.