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All About Revenues

 

Letís talk about money. For our purposes here, we have two kinds:

  • what "comes in" (= revenues)
  • what "goes out" (= costs and expenses)

Note a key definition here: What "comes in" is NOT income [or profit]. Income [a.k.a. net income, profit, net profit] is the difference between revenues and costs. 

So, if we are going to be able to help Charlie, it sounds as though we really need to find out a whole lot more about his revenues and costs if we are going to answer questions about profitability. But...maybe we'd better expand our own conceptual understanding of revenues, costs and profit before before we talk to Charlie.

Revenues

We characterized revenues as what "comes in;" that works for a very simple definition, but we need to be clearer about how this works. Think about the different ways a transaction might occur. Suppose you go to the local florist to buy flowers for your sister's birthday. The flowers cost $50 and you pay cash for them. The sale and the transfer of the payment for it take place simultaneously. You get your flowers and the florist gets her money. Everybody's happy. Now change the assumptions. You buy the flowers, but charge it on your personal account with the florist. Now the store owner has exchanged the flowers for a $50 liability which you agree to pay at some point in the future [when the "bill" arrives next month]. Everybody is still happy [as long as you pay, of course]. However, the timing of the exchange is separated from the timing of the payment. If the florist gets her money in the same fiscal period, there is essentially no difference between the credit transaction and the cash transaction. 

Now let's add some assumptions. It's almost the end December. You charge the flowers on your account, knowing that the statement from the florist won't come until some time after the first of January. The florist has a December 31 fiscal year. That means that she has to close her books at the end of December for the period beginning the previous January 1. The sale [revenue recognition] takes place in December of year 1. However, the cash impact [receipt of your payment] won't take place until January [or maybe not until February, depending on the exact timing of the closing period for your statement and the date you mail your payment]. This is a very simple illustration of why we use what is called accrual accounting. We need to be able to recognize the separation between the consumption or acquisition of resources and the payment received or made for those resources.

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Copyright © 2004 Gerald M. Myers. All rights reserved. This site has been developed as aid to instructors and students in managerial accounting. The scenarios contained herein are not intended to reflect effective or ineffective handling of managerial situations. Any resemblance to existing organizations is purely coincidental.
Last modified: August 03, 2005