Page 161 - DCOM409_CONTEMPORARY_ACCOUNTING

Contemporary Accounting

Notes expenses. For example, if customer signs an MoU for buying ` 10 lacs worth of products you
would not recognise this revenue in your accounting system because the products have not
changed hands and no transaction has taken place. You will only recognise the revenue once the
sale is made and the product is delivered to the customer so that you have a legal right to claim
payment. Now you can say that only the product has been delivered but the money has not come
in so you should not recognise the sale till the time the money is paid. A cash system of
accounting does exactly that. But the point this product has been given to him, he is under a legal
obligation to pay you the amount that is due to you. Therefore, under the accrual system of
accounting, you would recognise that this sale as revenue and the customer owns you money till
the time he pays up. Now this debt could also become a bad debt (money owned to you but
never paid) and therefore, you would provide for some losses that can happen due to bad debt
even before they happen depending upon the past experiences with your debtors.
The conservatism principle therefore, has two aspects:
1. Recognise revenues only when they are reasonably certain
2. Recognise expenses as soon as they are reasonably possible
These guiding principles are used while deciding the period in which the expenses and the
revenues fall in. Obviously, it leaves certain gaps in deciding what is meant by reasonably
certain and reasonably possible in various situations. Accounting standards do provide certain
guidelines for many specific problem areas but their abuse is quite common in India.

Therefore, you have to provide for losses that you reasonably expect but not the revenues that
you may expect in the future to make the accounting figures reflects a conservative approach.

13.2.8 The Realisation Concept

The sale is considered to have taken place only when either the cash is received or some third
party becomes legally liable to pay the amount.
We have just learned from the conservatism principle when the revenue should be recognised.
Realisation concept indicates the amount and revenue that should be recognised from a given
sale. The concepts states that the amount recognised is the amount that is reasonably certain to
be realised. Note the words ‘reasonably certain’. Differences of opinion are there when
interpreting what is ‘reasonably certain.’
The concept allows for the amount of the revenues recognised to be less than the selling price of
the goods or services sold. If the products are sold at a discount, then the revenue is recorded at
the lower amount and not at the normal price (also called the list price). When the goods are sold
on credit, you can never be sure of the amount that would be realised, so, you provide for bad
debts also.

13.2.9 The Matching Concept

When an event affects the revenues and expenses, the affect on each should be recognised in the
same accounting period.
As you already know, the sale of the products has two aspects:
1. Revenue aspect
2. Expense aspect
Revenues earned because the sale is going to fetch you some money and expenses incurred for
producing that product or providing that service. Correct measurement of the net effect of the
sale and expenses in any accounting period can only be made when you match the relevant
expenses to its related sales. Otherwise, it will allow a lot of freedom for not showing the true

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