Principles 2 and 3: Accrual Basis

Accrual basis of accounting is one of the most important concepts in accounting, and governs the company’s timing in recording its revenues (i.e., sales) and associated expenses.

• Principle 2: Revenue Recognition. Accrual basis of accounting dictates that revenues must be recorded when earned and measurable.

• Principle 3: Matching Principle. Under the matching principle, costs associated with making a product must be recorded (“matched” to) the revenue generated from that product during the same period.

4. Amazon.com Sells a Book

Exercise Q1: The following transactions occurred on the specified dates: Amazon.com purchases a book from a publisher for $10 on May 5, 2006. Amazon.com receives a $20 credit card order for that book on December 29, 2007. The book is shipped to the customer on January 4, 2008. Amazon.com receives cash on February 1, 2008. From the options above, when should Amazon.com record revenue? Expenses?

4. Amazon.com Sells a Book

Solution Q1: In line with the accrual principles of accounting, Amazon.com will record $20 in revenues and $10 in expenses on January 4, 2008. Amazon.com purchases a book from a publisher for $10 on May 5, 2006. Amazon.com receives a $20 credit card order for that book on December 29, 2007. The book is shipped to the customer on January 4, 2008. Amazon.com receives cash on February 1, 2008. Q2: Why can’t companies immediately record these revenues and expenses? According to the revenue recognition principle, a company cannot record revenue until that order is shipped to a customer (only then is the revenue actually earned) and collection from that customer, who used a credit card, is reasonably assured. Q3: Why shouldn’t Amazon.com record the expense when it actually bought the book? According to the matching principle, costs associated with the production of the book should be recorded in (matched to) the same period as the revenue from the book’s sale.