Question

At the end of its 2020 fiscal year, Pastel, Inc., received an order from a customer for $40,000. The merchandise will ship early in 2021. Because the sale was made to a long-time customer, the controller recorded the sale in 2020. Do you agree or disagree with the financial reporting practice employed? What accounting concept is applied (if you agree) or violated (if you disagree)?

Answer 1

Do you agree or disagree with the financial reporting practice employed?

• They shouldn't have recorded the $40,000 as revenue during this year.

What accounting concept is applied (if you agree) or violated (if you disagree)?

• The accrual principle states that revenue should be recognized once the earning process is completed and in the same accounting period when it occurs. In this case, the $40,000 should be recorded as a liability under the unearned revenue account until the merchandise is actually shipped to the client, and then it can be recorded as revenue.

Answer 2

The answer is:

Disagree

The matching principle is violated

Step-by-step explanation:

The order of a customer worth $40, 000 was received at year end. However, the merchandise will only ship in the year following the fiscal year. When goods are shipped, revenue is recognised on shipping the goods or receipt of the goods by the customer. According to the information provided, merchandise will only be shipped in 2021, therefore the customer will only receive the goods in 2021. Given this information, recognising revenue in the current period would be an incorrect treatment of the transaction and contravene the matching principle. This principle indicates that revenue and the costs associated with the revenue should be recognised in the same period.

The sale should not be recognised in 2020 because the goods' delivery and the costs incurred in delivering those goods will only be incurred in 2021. No indicated payment, cash or otherwise, was received in lieu of this transaction. Recognising this sale in the income statement and the associated asset in the statement of financial position could be misconstrued as an attempted enhancement of Pastel Inc.'s financial position for the 2020 fiscal year end.