Abstract In this text, I will address key accounting issues including but not limited to the revenue recognition principle and the differences existing between a period and a product expense. I will also discuss the matching concept. In the second part of the text, I will use the income statements of two major companies to carry out brief analysis of their performance.
¶ … Accounting Concepts
Revenue Recognition: Its Relevance and Significance
In the words of Kimmel, Weygandt and Kieso (2008), "the revenue recognition principle requires that companies recognize revenue in the accounting period in which it is earned." Unlike is the case in the cash basis of accounting, revenue under the accrual accounting basis is recognized on the sale of a certain commodity or the performance of a given service. Under the cash basis of accounting, the recording of revenue according to Kimmel, Weygandt and Kieso (2008) takes place when cash is received. Further, the authors point out that in this case, the recording of expenses takes place after cash is paid out.
It should be noted that alongside other accounting rules and principles, revenue recognition remains one of GAAP's most important standards. In most cases, companies do not receive payment for goods sold at the exact time of sale. This is more so the case in large corporations where most sales are made on credit. The accuracy of financial data is in one way or the other enhanced by subjecting all business entities to uniform revenue recognition rules/standards.
It is however important to note that the revenue recognition principle has been abused in the past. As Kimmel, Weygandt and Kieso (2008) point out, some of the companies that have been accused of abusing this principle include Krispy Kreme. In this particular case, the company was accused boosting its quarterly results by doubling the number of doughnuts sent out to clients buying in bulk. Afterwards, these bulk buyers would seek a refund after shipping back the doughnuts that remained unsold.
Product and Period Expense: The Difference
Product costs according to Drury (2007) "are those costs that are identified with goods purchased or produced for resale." Examples of product costs in that regard include direct labor and direct materials. On the other hand, period expenses in the opinion of Drury (2007) "are those costs that are not included in the inventory valuation and as a result are treated as expenses in the period in which they are incurred." Examples in this case include executive salaries, entertainment and travel expenses, expenses associated with advertising, etc.
The Matching Concept and How it Relates to Accounting for Inventory and Revenues
The matching concept, an important principle in accounting, is defined by Porter and Norton (2010) as "the association of revenue of a period with all of the costs necessary to generate that revenue." In basic terms, the matching principle dictates that entities embrace the accrual basis of accounting. A good example of the matching principle in application is the reporting of sales commission expense not in the period in which the commissions were paid but in that period in which the sales were made. Similarly, employee wages should be identified as an expense not in the month when the workers were paid but in the month in which the said workers worked. Matching of the cost of inventory with revenue can be done once the revenue from the sale of inventory is recognized. According to this principle, an accountant should ensure that all revenues and expenses having a cause and effect relationship are recorded at the same time, i.e. In the same accounting period. The matching concept plays a key role in the aversion of earnings misstatement.
Part 2
In this section, I will come up with a simple analysis of the financial statements of two major companies i.e. Philips and Apple. In the case of Philips, the income statement I shall subject to analysis is for the financial year ended 30th December 2011. When it comes to Apple, the income statement I will look into is for the financial year ended 24th September 2011. The links to the balance sheets I will be analyzing are given below:
Apple: http://files.shareholder.com/downloads/AAPL/2041497613x0xS1193125-11-282113/320193/filing.pdf
Philips: http://www.annualreport2011.philips.com/downloads/index.aspx
The Accounting Conventions and Auditing Standards Used by the Two Companies
According to Philips (2012), the company has been utilizing IFRS as its accounting standard of choice since the year 2009. Prior to that, the company was using U.S. GAAP. Apple on the other hand has U.S. GAAP as its sole accounting standard. Both companies utilize the Generally Accepted Auditing Standards (GAAS).
Table 1: A Comparison of Financial Items from the Income Statement of Apple and Philips
Apple
Philips
Item
2010
2011
Change
Item
2010
2011
Change
Total Revenue
65,225
108,249
43,024
Total Revenue
29,899
29,311
(588)
Cost of Revenue
39,541
64,431
24,890
Cost of Revenue
17,697
18,086
Gross Profit
25,684
43,818
18,134
Gross Profit
12,203
11,225
(978)
Operating
Income/
Loss
18,385
33,790
15,405
Operating
Income/
Loss
2,790
(349,000)
346,210
Net Income
14,013
25,922
11,909
Net Income
1,940
(1,681)
(3,621)
NB
All numbers are in Millions.
Brief Comment
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