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As part of the guidelines for financial statements, you know that costly concept – income with costs – is the foundation of accounting. Compared to just comparing the cash, these investors can develop to understand the profits of the business.
However, within generally accepted accounting principles (GAAP), there are many ways to identify income. Depending on what method has been chosen, financial statements may be quite different even though financial statements are the same.
Two Tests for Revenue Accreditation
For a valid income, there are two main conditions that must be completed. They are:
01 : Complete the earnings process
Under this test, the seller should not have any major responsibility for the customer. If the order for 500 football helmets is given and only 200 are distributed, the transaction is not complete. Similarly, if the seller is a manufacturer of components and promise of comprehensive warranty coverage, it should not be determined as sales revenue, while the costs can not be imposed for providing reasonable estimates of service (i.e., warranty repairs, labor and parts). Also, the company that sells the product with the unconditional return policy can not book the sale till the end of the window.
In order to book an income, the seller should potentially estimate that it will be paid for the order.
02 :Income validation method 1: Sale support
This is the method that investors often understand. Under sales base method, income at the time of sale is known. Sales can be cash or credit (i.e., for accounts that can be received). This means that even after getting cash, income can not be recognized for the transaction. For example, a magazine publisher earns $ 120 per year for annual membership, it will only recognize $ 10 revenue per month. The reason is simple: if they have gone out of business, they would have to return a pro-rated share to the subscriber’s annual subscription cost because it was not yet failed to deliver the payment.
Revenue Accreditation Method 2: Percentage of Perfection
Bridges or airplanes making companies have taken years to reach their products. In this case, the revenue products and profits responsible for the building products that the company wants to enable them to show to its shareholders, but the project is not yet completed. As a result, it will use the percentage of termination method for income identification if two conditions are fulfilled: 1) A long-term contract is legally enforceable and 2) it is possible to estimate the percentage of completed projects, as well as future income and expenses.
Under this method, there are two ways to get income identification:
The use of landmarks, such as the number of railway tracks, has been completed
A construction company is paid $ 100,000 to make a fifty-mile highway. For every mile, the company will identify $ 2,000 in revenues on its income details ($ 100,000 / 50 miles = $ 2,000 per mile).
Cost of estimated total cost
Using this metric, the construction company will achieve income certification by comparing the estimated total cost date. For example: Trade is expected to cost $ 100,000 worth of highway, 80,000 dollars, materials, labor etc. At the end of the first month, $ 5,000 has been spent on working on this project. $ 5,000 is $ 6.25 per 80,000; Therefore, it will increase the percentage of total revenues ($ 100,000) (6.25%), or $ 6,250, and its income statement will identify this amount as income. Warning: if you can read by 10k The company, which is fully utilizing the percentage of income recognition system, you want to check the costs of buying raw materials for premature bookings. Unless the product production cycle is actually used (for example, putting a real concrete on the work site, not buying concrete in the home depot), the price should not be calculated. A business that does not meet this difference, resulting in revenue for income, total profits and the risk of eliminating net revenue.
This is the most conservative income recognition system in all of these. When a project does not estimate the total costs required to complete the project, a cost recovery approach is used. The result of this is that no benefit is known until the cost of completion of the project is withdrawn. Examples include internal software and some types of land development.
Suppose that the law has developed its own software at a total value of $ 1 million. After many years, partner software decides to start licensing other companies. In the first quarter, their total sales are $ 250,000. Under the cost recovery
The income recognition mechanism, however, will act as the $ 1 million offset for all development costs. Nothing in the income statement will appear in the form of income unless the remaining $ 1 million is completely exhausted.
Revenue Recognition Method 5: Installment
When the actual collection of cash is suspicious, then the company should use the income taxation method. It is mainly used for real estate transactions, which may be agreed to sell, but the cash collection is subject to risk of falling through buyer’s financing. As a result, the total profit is only calculated in the amount of cash received.
For example, suppose the developer had spent $ 500,000 to upgrade the apartment. They sold the property for $ 750,000 but the buyer will pay in two installments – one January and one on July 31. On the date of first payment, the developer receives a check for half of his payment or $ 375,000. Their income details now show 50% of the revenue and total profits because they have collected 50% of the cash.
Be careful with manipulation
Because you can see, management can only change the appearance of heavy income identity and income statement, with accounting change, income or profit can understand. Instead of a complete agreement with a contract of higher property, high stokholder equity, lower liabilities and debt-to-equity ratio, the percentage of the measurement method of accentuation using a full mechanism. Despite the fact that business financial wealth and health are exactly the same, the income statement will show easy earnings for many years.
This is the only place where the investor should dig out the revenues of two companies in the same industry and compare it is actually doing well. The irony is that, with a few exceptions, a business that uses a complete contractual mechanism, is not going to inform any income of the first year of the contract, meaning that there will be no payment of taxes. The result is that the shareholders told that they are low income, but because of their property, the business of having business tax capital is going to be lagging high.
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