Unit 5
Accounting and Finance Foundations Unit 5: Accounting Terminology 315Accounting Terminology
Chapter 12
- Matching Principle
To avoid overstatement of income in any one period, the matching principle requires that revenues
and related expenses be recorded in the same accounting period.
If you bill $20,000 of services in a month, in order to accurately represent the income for the month,
you must report the expenses you incurred while generating that income in the same month. - Revenue Recognition Principle
Revenues are recognized when they are earned or realized.
The rule is to recognize or acknowledge revenue when we are reasonably certain that it exists and is
measurable. Likewise, we recognize expenses as soon as they are reasonably possible—when we
know that we have spent money on something or need to make a payment on a debt. The reason for
accounting in this manner is so that financial statements do not overstate the company’s financial
position. Accounting chooses to err on the side of caution and to protect investors from inflated or
overly positive results.
Realization or revenue recognition is assumed to occur when the seller receives cash or a claim to
cash (accounts receivable) in exchange for goods or services. Revenue (income) is only recorded
when it actually occurs and not at the point in time when a contract is awarded. For instance, if a
company is awarded a contract to build an office building, the revenue from that project would not
be recorded in one lump sum, but rather it would be divided over time according to the work actually
being done. - Disclosure Principle
Companies must fully disclose information that may impact decisions of users of financial
information.
Disclosures are presented in the financial statements as part of the notes to the financial statements.
The information disclosed helps the users of the financial statements to make financial, managerial,
or investing decisions. - Materiality
An accounting practice that states an organization only records events that are significant enough to
justify the usefulness of the information.
Technically, each time a sheet of paper is used, the asset “Office Supplies” is decreased by such a
small amount that individually recording transactions is not cost effective. Only when substantial
events (an entire ream or case of paper) occur do entries need to be made. - Cost-Benefit Relationship
This constraint is in place to ensure that the financial information provided by an organization is
beneficial enough to justify the cost of preparing it.
When developing its financial statements, the organization must take into consideration the costs
involved in preparing the information and the benefits users will derive from the financial statements.
This principle also exists to ensure that companies use conservative estimates and judgments when
preparing and providing their financial information. For example, a company cannot predict the
amount of money they will not collect from customers; instead, the company will make a conserva-
tive estimate based on past experience to determine uncollectible amounts.
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