explain how the assumptions and qualitative characteristics of accounting guide
ID: 2488439 • Letter: E
Question
explain how the assumptions and qualitative characteristics of accounting guide the choice of the following accounting methodsA. revenue recognition B. Accounting for bad dept explain how the assumptions and qualitative characteristics of accounting guide the choice of the following accounting methods
A. revenue recognition B. Accounting for bad dept explain how the assumptions and qualitative characteristics of accounting guide the choice of the following accounting methods
A. revenue recognition B. Accounting for bad dept
Explanation / Answer
Revenue Recognition
The revenue recognition principle is a cornerstone of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.
Cash can be received in an earlier or later period than obligations are met (when goods or services are delivered) and related revenues are recognized that results in the following two types of accounts:
Accrued revenue: Revenue is recognized before cash is received.
Deferred revenue: Revenue is recognized after cash is received.
Revenue realized during an accounting period is included in the income.
IFRS provides five criteria for identifying the critical event for recognizing revenue on the sale of goods
The first two criteria mentioned above are referred to as Performance. Performance occurs when the seller has done most or all of what it is supposed to do to be entitled for the payment. E.g.: A company has sold the good and the customer walks out of the store with no warranty on the product. The seller has completed its performance since the buyer now owns good and also all the risks and rewards associated with it. The third criterion is referred to as Collectability. The seller must have a reasonable expectation of being paid. An allowance account must be created if the seller is not fully assured to receive the payment. The fourth and fifth criteria are referred to as Measurability. Due to Matching Principle, the seller must be able to match expenses to the revenues they helped in earning. Therefore, the amount of Revenues and Expenses should both be reasonably measurable
Bad Debt
Trade receivables/debtors fall into the category of loans and receivables under IAS 39/FRS 26. They will be valued at fair value initially - which will be the invoiced amount. Because they are short-term receivables they will not normally be subject to discounting, nor will they normally have an effective interest rate. They will have to be assessed for impairment at each balance sheet date, and will be impaired if the present value of the cash flows is less than the carrying amount.
The terms 'bad debts' and 'irrecoverable debts' will still be used and will relate to specific debts which are not considered to be collectible and so are written off to the income statement/profit and loss account. Effectively, they are 100% impaired.
EXAMPLE 1
Note that the differences in terminology or narrative are in bold.
At 31 December 2004, a company's trade receivables/debtors totalled $864,000, and the allowance for receivables/debtors was$38,000. It was decided that specific debts totalling $13,000 were to be written off as the cash was considered to be irrecoverable, and the allowance for receivables/debtors was to be adjusted to the equivalent of 5% of the trade receivables/debtors based on past experience.
QUESTION
That figure should appear in the balance sheet for trade receivables/debtors and in the income statement/profit and loss account for the total of bad debts and the allowance for trade receivables/debtors?
ANSWER
Balance sheet
Trade receivables/debtors $808,450
($864,000 - $13,000 - $42,550)
Income statement/Profit and loss a/c
Bad debts $13,000
Allowance for trade receivables/
debtors ($42,550 - $38,000) $4,550
[($864,000 - $13,000) x 5% = $42,550]
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