Five Accounting Principles that You Should Know

Revenue Recognition Principle

Cost Principle

Matching Principle

Objectivity Principle

Full Disclosure Principle

Revenue Recognition Principle

This highlights the period of time when revenues are recognised through the income statement of your company. If
you are on an accrual basis, your revenues will be recognised in the period that the services were provided. For
better understanding, the term accrual refers to accumulating or receiving (payments or benefits) over a period of
time.

Alternatively, if you are on a cash basis, the revenues need to be recognised in the period the cash was received.
With this, your business can provide accurate financial statements that reflect its true revenue and profitability.

Cost Principle

This refers to recording your assets at their original cost rather than their current market value. Doing this allows
you to properly record depreciation for purchased assets orderly. By adhering to this principle, you can prevent
from overstating business assets and present a more accurate picture of its financial position.

Matching Principle

Expenses should be matched to the revenues recognised in the same accounting period and be recorded in the period
the expense was incurred. If there is a period of time where revenue was recognised on sold products or services,
then the cost of those things should also be recognised.

Objectivity Principle

The accounting data should consistently stay accurate and be free of personal opinions. Make sure the data is also
supported by evidence that can include vouchers, receipts, and invoices to maintain consistency.

Full Disclosure Principle

The information on financial statements should be accurate so that nothing is misleading. With this intention,
important stakeholders will be aware of relevant information concerning the finances of your company. Similarly,
you can build trust between stakeholders with your company with the transparency.

How Accounting Principles Applies in Business Financial Management?

After learning all the heavy theories, what are the benefits that business owners like you can leverage from it?
Here’s a list:

Accurate and reliable financial information, Identify financial trends, Informed decision-making based on data
collected, Reduce the risk of fraud, Build solid rapport and increase credibility with stakeholders

‍How can hiring a chartered accountant or outsourcing an accounting service benefit a company?

This can help businesses to stay up-to-date with the latest developments in the industry and improve their financial
performance.

Hiring a chartered accountant or outsourcing an accounting service can bring several benefits to a company. Firstly,
they can provide businesses with expert financial advice and help them to manage their finances more effectively.
They can also ensure that businesses comply with financial regulations and avoid any legal issues. Secondly,
outsourcing accounting services can save businesses time and resources. By outsourcing, you can focus on business
core operations and leave financial management to experts. This can also reduce overhead costs and increase
efficiency.

Finally, outsourcing accounting services can provide businesses with access to the latest accounting software and
technology. This can help businesses to streamline their financial management processes and reduce the risk of
errors.
When is revenue recorded?
So if you don’t record the revenue when the cash hits your bank account, when do you record it?
Revenue recognition depends on the timing and sequencing of the two main events that make up any transaction:
Delivering goods or services (the revenue-generating process); and
Receiving payment for said product or service per outlined payment terms.
Both events are independent. Retail stores, for example, handle payment and product delivery simultaneously, but
for many businesses, one event frequently occurs before the other.
Let’s take a look at the three different situations in more detail.
Immediately upon receiving payment This is the simplest example of revenue recognition—you deliver the
product or service immediately upon purchase, and you record the revenue immediately.

Revenue for one-time purchases should be recognized immediately.

This is most common with one-time purchases, like buying groceries or one-time software packages. Because the customer
takes possession of the product immediately, revenue can be realized on your income statement in the same accounting period
as payment was received.

After payment is received

It’s also common practice for companies to wait to record revenue until they deliver the product or service to customers. This
should be familiar to most SaaS and subscription-based businesses—the customer pays upfront for a fixed period (usually a
month or a year), and the service is delivered over that time period.

Even though the booking for the entire year is received upfront, revenue is recognized equally across the 12-month period.

If you get paid to provide a service for a month or a year, but you receive the money immediately, that payment should be
gradually recognized as revenue. Each month that you provide the service for the prescribed time means recognizing an equal
portion of that income until the service delivery period is complete.

Before payment is received

Last but not least, revenue can also be recorded after delivery of the product or service but before payment is received.
Companies don’t need to wait until payment is collected to record it as revenue. This is a key concept in accrual accounting
and usually applies to service-based businesses like consultancies. A service performed in March, for example, should be
realized on March financial statements, even if a client pays for said service in May.
Four common revenue recognition examples

We get it—wrapping your head around all of this can be confusing. The easiest way to explain when you should
recognize revenue in your own business is by seeing it in action, so let’s look at a few revenue recognition
examples.

1. Traditional software companies

Meet Company A, a software company selling an on-prem CRM package for enterprise customers. Instead of
running a SaaS product, Company A delivers their software the traditional way - a one-time software package,
installed on local hardware run by the customer.

Say Company A releases a new version in January, and the new version costs $10,000 upfront. If a customer
purchases and receives the software in January, the company can book the sale and recognize all $10k of the
revenue in the same month.

This is the simplest example of revenue recognition. Because the customer takes possession of the software
immediately and runs it on their own hardware, the seller can recognize the revenue immediately. Retailers like
grocery stores work the same way—revenue is recognized upon delivery, when customers buy their groceries.

Even with this straightforward example, though, it’s still important to recognize the difference between cash and
revenue. That difference becomes more apparent in our next example.

2. SaaS companies

Let’s move on to Company B, another CRM software provider who develops a SaaS product. Instead of a one-
time charge like Company A, though, Company B charges a $10,000 subscription fee each year for access to
their service, and most customers pay for the entire year up front.

Take a look at what happens when a customer signs up for one year on January 16th:

The difference with subscriptions? Company B still has to earn their revenue, even though the customer has
already paid for the whole year in advance. Delivery of the service spans the whole year—this means
recognizing revenue on a straight-line basis where revenue recognition occurs monthly and the rest is deferred
revenue, even though Company B's already seeing an improvement in their cash flow.

The problem with SaaS is that the subscription business model falls between the gaps of GAAP. There aren’t any
specific revenue recognition standards for SaaS businesses. This is where a number of SaaS companies trip up—
since there aren’t any accounting standards, they fail to realize that they have to recognize the revenue for a
service incrementally throughout the time window for that service. If you recognize all the revenue upfront and
then spend the cash, if a customer comes to you asking for their money back, you’ll likely find yourself up the
proverbial creek without a paddle.

3. Retailers

Now, let’s jump out of the software world. Company C sells appliances, and their lack of showroom space means
customers often purchase dishwashers, fridges, and other items without being able to accept the products on the
spot. Instead, they schedule delivery and installation for a later date.

Say Company C sells an appliance package to a customer on January 16th for $10,000. The customer pays for
the appliances on February 10th, but the appliances aren’t delivered until March 3rd. Let’s see how it plays out
(you can ignore MRR since renting appliances isn’t common):

Company C should recognize their revenue when items are delivered to the customer, even if paid for in the
weeks or months prior. In this specific example, Company C should record the revenue in March—since that’s
when the products were delivered—even though the sale was booked in January and paid for in February.

4. Service providers

Our final example comes from the consulting world. Company D is a marketing firm that provides digital
marketing solutions to growing startups. Say Company D provides $10,000 in marketing services to one of its
clients in January, but the client doesn’t pay for those services until April:

Revenue recognition for service-based work like consulting happens at the time of consulting (when revenue was
realized and earned) even if the client pays at a later time. This means Company D should recognize their client
revenue in January, even though the cash for those services wasn’t received until April.

(Software as a Service (SaaS) is a software licensing model, which allows access to software on a subscription
basis using external servers.)