Financial Accounting: In an Economic Context

ACCOUNTS RECEIVABLE FROM A USER'S PERSPECTIVE

When accounting for short-term receivables, two general questions are of significant economic importance: (1) When should a receivable be recorded in the books? (2) At what dollar amount should a receivable be valued on the balance sheet?

When Should a Receivable Be Recorded?

Revenues and related receivables are recognized when the four criteria of revenue recognition have been met. Establishing exactly when this occurs, however, is difficult and subjective because managers have freedom to determine when and how a sale and the associated receivable are recorded. This freedom gives rise to widely different practices. For example, General Electric recognizes revenues when goods are shipped, while HarperCollins, 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 twenty-six (13 percent) companies waited until cash was received before recognizing a sale, while thirty (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 principles, 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 an accounting ...