Companies have a great incentive to maximize their profits, and boost their earnings. To do that, they should generate more revenues and lower their expenditures. In this article we will spot the light on all matters related to revenues and expenses.
First of all, we will explain revenues and expenses and give a lot of examples about sources that generate revenues and consume expense. In this context we will know that Revenue (sales) is the amount received from selling products and services, and expenses are the money spent, or costs incurred, by a business in their effort to generate revenues. After that, we will explain the accounting treatment for both revenues and expenses and how they are reported in company financial statements, and the intended purposes of both revenue recognition principles and expense recognition principles.
In addition to that, we will explain the conditions that may create accrued expenses for the company; also we will illustrate the meaning of expenses and definitions of revenue expenditures. Finally, we will know how ERP System can be useful in recognizing revenues and expenses in an accurate and timely manner.
One of the most important accounts in any business company are revenues accounts. Generating profit is the main objective of any profit company, and they seek all the time to achieve a high level of revenues. Revenues can be seen as the gross increase in owner’s equity (via net income) resulting from business activities entered into for the purpose of earning income. Revenues usually result in an increase in an asset and can be generated from many company activities and operations such as selling merchandise, performing services, renting property, and lending money.
Revenues can be arises from many different types of resources and are called various names depending on the nature of the business. For example, in service companies revenues are named according to its source such as (fees, commissions, interest, etc.), but in merchandising and manufacturing companies they are called sales because it is generated from selling products to customers. Common sources of revenue are sales, Professional Fees, services, Commissions, Interest, dividends, royalties, consulting services, and Rent.
The purpose of earning revenues is to benefit the owner(s) of the business, and companies should spent money to achieve their revenues. So, to maximize the benefit to the owners, companies should generate revenues greater than expense, because in this case this would achieve profit and increase equity. Revenues are matched with expenses at the end of each accounting period to measure the company performance and the result of company operations.
To achieve a high level of profit, companies should control and minimize the level of their Expenses. Expenses are the costs necessary to generate revenues, and represent the cost of assets consumed or services used in the process of generating revenues.
Expenses have a negative effect on owner’s equity and result of company operations, if the amount of expenses spent during the accounting period exceed the amount of revenues generated , then company will suffer losses and owner`s equity will be decreased. Expenses should be matched with revenues it generates at the end of each accounting period.
Companies may incur expenses and spend a lot of money on many aspects such as salaries and wages, utilities (electric, gas, and water expense) delivery (gasoline, repairs, licenses, etc.) supplies (napkins, detergents, aprons, etc.), rent, interest expense, production ingredients, advertising, insurance, and property tax expense.
Generally, expenses represent an amount of money needed or used to do or buy something. But In accounting, expense has a very specific meaning and meaning can be tailored to the source of expenditures. In accounting expenses includes an outflow of cash or other valuable assets from a person or company to another person or company. An expense is the cost of operations that a company incurs to generate revenue. As the popular saying goes, “it costs money to make money.”
Expenses are called various names depending on the nature of the business and the source of expenditure, and can be appear on the income statement under five major headings which are; Cost of Goods Sold “COGS” (is the cost of acquiring raw materials and turning them into finished products), Operating expenses ( are related to selling goods and services and include sales salaries, advertising, and shop rent), Financial Expenses ( are costs incurred from borrowing or earning income from financial investments and include loan origination fees and interest on money borrowed ), Extraordinary expenses (are costs incurred for large one-time events or transactions outside the firm’s regular business activity and include laying off employees, selling land, or disposal of a significant asset), Non-Operating Expenses ( are costs that cannot be linked back to operating revenues), and Non-Cash Expenses ( such as depreciation)
Cost of Goods Sold “COGS” category differ according to natural of the business where it is called Cost of Goods Sold in manufacturing companies , and called cost of services in service companies, also called cost of sales in merchandising companies.
When companies consume services of other such as time, effort, place, and money. They should pay for these services, here we have two options; company may choose to pay for expense immediately or postponing the payment to a later date. If the company postpones the payment, she will create an accrued expense.
An accrued expense is an accounting term that refers to an expense that is recorded on the books before it has been paid; the expense is recognized in the accounting period in which it is incurred. They are shown on a company’s balance sheet as current liabilities because they are represent future obligation which due within one year of the date of the transaction. So accrued expenses are those liabilities that have built up over time and are due to be paid.
Examples of accrued expenses include Interest on loan that is matured but not paid yet, Utilities used for the month but an invoice has not yet been received before the end of the period, Goods received but the invoice has not been received yet, Wages that are incurred but payments have yet to be made to employees, Services consumed but the invoice has not been received yet, etc.
According to accrual base of accounting, expenses should be recognized when they are incurred, not necessarily when they are paid. And Companies should make adjustments for accrued expenses to record the obligations that exist at the balance sheet date and to recognize the expenses that apply to the current accounting period.
Revenue and expenses
Company’s expenditure may benefit the company during the current year only, or usefulness may be extended to include many years. If company expenditures will be expensed in the accounting period, they are called revenue expenditures. But, if expenditures will be consumed over a long period of time (more than one year), they are called capital expenditures.
Revenue expenses are incurred when a company buys products or consume services necessary for generating revenue in the short term (only one year). Revenue expenditures tend to be small. These small costs will be listed as expenses in the current accounting period and will offset against revenue immediately.
Generally, anything your company purchase and not a fixed asset falls under revenue expenditure category, beginning from stationery needs to building maintenance. Revenue expenditures are reported on the monthly revenue bill against that expense period’s revenue.
Revenue expenditures are the ongoing operating expenses and used to run the daily business operations. These expenditures do not increase the profit-generating capacity of a business. However, it comes in handy in maintaining the operational activities and helps to manage assets better. These expenditures include many expenses such as; Routine repair/update costs on equipment, Smaller-scale software initiative or subscription, Utilities and Rent, Salaries and wages, Insurance, Advertising, Business travel, Property taxes, and any overhead expense.
Recognizing revenue and expense
It can be difficult to determine the amount of revenues and expenses to report in a given accounting period, so accounting standards provide the general guidelines and standards for measuring and recognizing revenues and expenses. The most important rules that should be adapted in recognizing revenues and expenses are revenue recognition principle and expense recognition principle.
The revenue recognition principle requires that companies should recognize revenue in the accounting period in which it is earned. In a service enterprise, revenue is considered to be earned at the time the service is performed. But in merchandising and manufacturing companies, revenue is considered to be earned when goods are sold. So the earnings process is normally complete when services are performed or a seller transfer’s ownership of products to the buyer, and Proceeds from selling products and services need not be in cash.
Revenues must also be earned (usually occurs when goods are transferred or services rendered), regardless of when cash is received. For companies that don’t follow accrual accounting and use the cash-basis instead, revenue is only recognized when cash is received. So Companies can recognize revenue at point of sale if it is also the date of delivery or if the buyer takes immediate ownership of the goods.
In recognizing expenses, Accountants follow a simple rule in recognizing expenses which is “Let the expenses follow the revenues.” Thus, expense recognition is tied to revenue recognition. This practice of expense recognition is referred to as the expense recognition principle (often referred to as the matching principle). It dictates that efforts (expenses) be matched with results (revenues).
According to expense recognition principle, the expense recognition (or matching) principle aims to recognize expenses in the same accounting period as the revenues that are earned as a result of those expenses. This matching of expenses with the revenue benefits is a major part of the adjusting process.
Revenues and expenses accounts are temporary accounts that should be closed at the end of accounting period, In preparing closing entries, companies could close the revenue and expense accounts to another temporary account, Income Summary, and they transfer the resulting net income or net loss from this account to owner’s capital.
Revenue has a credit normal balance, so revenue accounts are increased by credits and decreased by debits. In contrast, expenses have a debit normal balance, so revenue accounts are increased by debits and decreased by credits.
Using ERP system in recording revenues and expense
Enterprise resource planning (ERP) solutions are a key strategy that assists companies to comply with revenue and expense recognition requirements and help in increasing automation and report financial results in an accurate and timely manner.
Modern ERP platforms are designed to help organizations to comply with the process of revenue recognition outlined in many aspects as following:
• ERP System help organizations to identify the contract with a customer, and identify the transactions that represent a customer contract.
• ERP solutions help organizations to identify the performance obligations in the contract. Where, ERP system can gather information on expectations, and promised goods and services can be gathered from source documents.
• ERP solutions help organizations to determine the transaction price. Where, ERP system can collect the elements of the transaction price from all applicable source documents.
• ERP solutions help organizations to allocate the transaction price to the performance obligations .Where, ERP system can automate allocation processes based on standalone selling prices.
• ERP solutions help organizations to Recognize revenue when (or as) each performance obligation is satisfied: ERP systems help keep track of whether revenue should be recognized over time or at a point time and help calculate the revenue that should be recognized each period if revenue should be recognized over time.
In addition to that, ERP system can automate revenue recognition processes, including foreign exchange gains or losses, as well as establishing the correct asset and liability balance. Regardless of whether your business provides products, services or both, when contracts are entered into with customers, modern ERP systems can help you calculate and present revenue accurately within financial statements.
Revenues and expense are the most important accounts in determining the results of company operations at the end of accounting period. Revenues represents the value of goods sold or/and services performed, companies usually recognize revenues when it is earned, companies earned revenues when goods sold or service performed. Companies should follow revenue recognition principles when recording and measuring revenues.
Expenses represent all expenditures or costs spend out to generate revenues, expenses should be matched with revenues it generates at the end of accounting period to determine the result of company operations (profit or loss). Expenses may be paid immediately or postponed to a later date, if it postponed it will create a liability for accompany and should be recorded as liability and adjusted at the end of accounting period.
Company expenditures may be revenue expenditure or capital expenditures, Revenue expenditures or operating expenses are recorded on the income statement. These expenses are subtracted from the revenue that a company generates from sales to eventually arrive at the net income or profit for the period.
Companies should adapt ERP system in recognizing revenues and expense and preparing financial statements. ERP system can automate revenue recognition processes, and help organizations to Recognize revenue when (or as) each performance obligation is satisfied, and assists companies to comply with revenue and expense recognition requirements and help in increasing automation and report financial results in an accurate and timely manner