Financial and Managerial Accounting Modules
Ethical Issues and Accounting Choices
According to accounting standards, the revenues should be recorded in the financial statements as Accounts Receivable. The standards assert that the financial transaction be recorded as a sale even though cash has not yet been received for the good provided to the customer. Revenue from the transaction is recognized once the service has been fulfilled and not necessarily when the company has received cash for the good or service. The company has received a valid promise for future payment and this amount needs to be credited in the sales section of the balance sheet.
A number of stakeholders will be affected by the decision to include the uncollected payment as revenue in financial statements. The purpose of the financial statement is to provide a transparent picture of the company’s financial position. The stakeholders need to know if there is any uncollected revenue and how this affects the overall financial performance of the company. The stakeholders that will be affected by the decision include the shareholders of the company, management, and the Wall Street analysts.
The shareholders of the company want to have a snapshot of the company’s current financial status to determine if further or continued investment is prudent, while the management needs to be able to explain any discrepancy between sales and actual cash collected. The Wall Street analysts need the total revenue figures, collected and uncollected, to determine if the company has achieved its earnings estimates.
Understanding Revenue Recognition and Expense Recording
The fact that GAAP is written as broadly as it is, is in fact a good thing. The broad guidelines help companies to know what to do when there is no specific information given. The guidelines are important when there is a lack of complete information about certain elements of revenue recognition and expense recording. There will always be an instance when there is lack of complete information that guides a company on what to do when it encounters a certain problem in its financial reporting. GAAP’s broad guidelines can help such a company in determining its next move on the matter.
The broad guidelines are also essential as they provide consistency in reporting. Consistency in reporting will help the investors conduct financial analysis easier than if every company was adhering to stricter rules. Furthermore, making comparisons between a company and its competitors using financial statements is made easier due to the consistency in reporting provided by the broad GAAP guidelines.
A classic Machiavellian argument is that the end will justify the means. When applied to managing earnings, the argument rings true in that, when the stakeholder views the company’s financial statement, he will not view the company in a bad light. The company is also able to remove financial items that might distract the shareholders and creditors or cause confusion among them. One disadvantage of managing earnings is that the shareholders and creditors might feel cheated when they notice some discrepancies in the financial statement regardless of how little they are. The mis-trust may cause friction between the company, and its investors and creditors.