Final answer:
A company can recognize revenue from a long-term contract when it meets certain criteria, ensuring the revenue reflects true economic benefits. The company's ability to earn significant revenues and profits establishes trust to borrow money through banks and bonds.
Step-by-step explanation:
Long-term contracts are fundamental to a company's ability to recognize revenue, which is accounted for under specific accounting principles. A company satisfies a performance obligation and is allowed to recognize revenue from a long-term contract only if certain criteria are met. These criteria are designed to ensure that the revenue reported is a genuine reflection of economic benefits flowing into the company. Typically, for a revenue to be recognized there must be a persuasive evidence of an arrangement, delivery has occurred or services have been rendered, the seller's price to the buyer is fixed or determinable, and collectability is reasonably assured. If these conditions are not met, the recognition of revenue must be deferred until such a time as they are met. This is in line with the principle that economic activity is recognized when it is earned, regardless of when cash is exchanged.
For example, when a business establishes that it has begun to earn significant revenues or profits, it stands in a better position to honor its debt commitments. Such financial stability allows a company to make credible promises to pay interest and hence borrow money through banks and issuing bonds. These two methods represent the primary ways in which a firm can secure long-term financing.