When accounting for short term receivables, two general questions are of significant financial importance. (1) When should receivables be recorded on the books? and (2) At what dollar amount should a receivable be valued on a balance sheet? Below we will discuss these questions.
Revenues and related receivables are recognized by business entities when four criteria of revenue recognition are met. Establishing exactly when this occurs, however, is difficult to and subjective. An article from Forbes magazine indicates that “managers have a good bit of freedom to determine when and how a sale (and the associated receivable) gets put on the books.” This freedom gives rise to widely different practices for example, General Electric recognizes revenues when goods are shipped, while Harper Collins, a large book publisher, recognizes revenues when it invoices customers, sometimes a month before orders are shipped. Revenue recognition practices even differ among companies in the same industry. A survey of 200 software companies, for example, revealed that 26 (13 percent) companies waited until cash cash was received before recognizing a sale, while 30 (15 percent) companies recognized a sale as soon as an order was received.
Users of financial statements must realize that, even within the guidelines of generally accepted accounting principals, managers can use discretion to speed up or slow down the recognition of revenue. This concern is particularly important for transactions that occur near the end of accounting period. Recognizing a receivable and revenue on December 30 instead of January 2, for example, can significantly affect current assets, working capital, and net income on the December 31 financial statements.