Revenue and Expense

As with everything else in accounting, the terms revenue and expense have definitions. They are not difficult so define, but professional judgment is required to apply the definitions correctly, and in conformity with GAAP. You need to develop a working definition for both terms.

According to FASB in SFAC No. 3, "revenue is derived from delivering or producing goods, rendering services, or other major activities of the firm.” In his book Accounting Theory, (fourth edition, Irwin), Eldon S. Hendriksen comments,

"Revenue is best measured by the exchange value of the product or service of the enterprise....we still have the problem of deciding the point or points in time when we should measure and report the revenue....[I am] in general agreement with [the] view that revenue should be acknowledged and reported at the time of the accomplishment of the major economic activity if its measurement is verifiable and free from bias.

The term revenue realization is used in a technical sense by accountants to establish specific rules for the timing of reporting revenue under circumstances where no single solution is necessarily superior to others in the above context of revenue…..The general view is that realization represents the reporting of revenue when an exchange or severance has occurred. That is, goods or services must have been transferred to a customer or client, giving rise to either the receipt of cash or a claim to cash or other assets [accounts or notes receivable]….Thus, the term realization has come generally to mean the reporting of revenue when it has been validated by sale."

There might be other times revenue will be recorded and reported, not related to making a sale. For instance, long term construction projects are reported on the percentage of completion basis. But under most circumstances, revenue will be recorded and reported after a sale is complete, and the customer has received the goods or services.

According to Hendriksen, "...expenses are the using or consuming of goods and services in the process of obtaining revenues.... Frequently, expenses are defined in terms of cost expirations or cost allocations...be careful to distinguish between the measurement of an expense based on cost and the definition of an expense as an activity or process. Emphasis on the latter has the advantage of leaving the measurement of expense open for further discussion."

At the end of the year, or anytime before financial statements are prepared, accountants have to make certain adjustments to the books to make sure that all revenues and expenses are correctly recorded and reported. This is where adjusting entries, accruals and deferrals, come in. Some companies make adjusting entries monthly, in preparation of monthly financial statements.