Because business generally cannot end its operations and prepare its financial statements, it poses quite
a few problems. Accounts are not properly stated at their current value, which will lead to
u]]v]}v}(Z}uvÇ[(]vv]o}]]}vXounting divides the economic life of a business
into artificial time periods, with accordance to the time period assumption.
Revenue Recognition Principle
The revenue recognition principle states that revenue must be recognized in the accounting period in
which it is earned. In merchandising, revenue is earned when merchandise is sold. In service, revenue is
considered earned when the service is performed.
recognition is tied to revenue recognition. The critical issue in expense recognition is determining when
the expense contributes to revenue. The practise of expense recognition is referred to as the matching
principle because it states that efforts (expense) must be matched with accomplishments (revenues)
wherever this is possible.
Accrual versus Cash Basis of Accounting
The combined application of the revenue recognition and matching principle results in accrual basis of
statements are recorded in the periods in which the events occur, rather than when the company
actually receives or pays cash. An alternate to accrual is cash basis of accounting. This is when revenue is
recorded only when cash is received, and an expense is recorded only when cash is paid.
The Basics of Adjusting Entries
For revenues to be recorded in the period in which they are earned, and for expenses to be matched
with the revenue they generate, adjusting entries are made to update accounts at the end of the
accounting period. Adjusting entries are necessary because the trial balance t the first pulling together
of the transaction data t may not contain complete and up-to-date data. This is true for several reasons:
1. Some events are not recorded daily, because it would not be useful or efficient to do so (i.e.
2. Some costs are not recorded during the accounting period because these costs expire with the
passage of time rather than as a result of recurring daily transactions (i.e. rent)
3. Some items may be unrecorded (i.e. bills)