Question

BE2-10 (L06) Identify which basic principle of accounting is best described in each item below.

1. Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected.
2. Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.
3. Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.
4. Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.

Short answer

(a) Revenue recognition

(b) Matching principle

(c) Full disclosure

(d) Historical cost

Step-by-step solution

Definition of revenue

Revenue is an income to the company arising due to normal course of business activities. Generally, it will occur by giving services to customers and sale of goods, and some companies getting this revenue from interest, fees and royalties.

(a) Revenue recognition principle

Reason - Revenue is recognized in the period it is earned (GAAP)

Revenue recognition principle: Revenue is recognized for accounting records as and when the related performance obligation is complete. The performance obligation arises if a company sells a product or provides service to its customer. Once the performance obligation is satisfied by a company it should record revenue in the respective accounting period.

(b) Matching principle:

Under the matching principle in accrual basis accounting, expenses are matched with the benefits derived from the expense in the same income statement period. Expenses, which do not pertain to a period, are excluded from reporting in the period.

Reason - Expense is matched with the period revenue is earned.

(c) Full Disclosure principle

Reason - Pending lawsuit is disclosed to its investor as a foot note.

Full disclosure about all the disputes and conflicts against the company need to be shown and other perceived problems and liabilities and legal issues need to be disclosed in order to maintain transparency.

(d) Historical cost

Accounting is concerned with past events and it requires consistency and comparability that is why it requires the accounting transactions to be recorded at their historical costs. This is known as historical concept.

Reason - Cost in the balance sheet is the cost it acquired.

Historical cost is the cost, which is there on the day of transaction, which is the past event cost.