TO: Ms Connie Rocha Aunt Connie's Cookies
SUBJECT: Recognizing Future Income from Firm Orders
RE: Your Request for Advice on Demonstrating Financial Strength to Bankers
Your business, Aunt Connie's Cookies, is in a strong financial position considering the size of the business (dollar volume of sales), and your current balance sheet demonstrates the financial strength of the business. The balance sheet reflects an equity position that equals approximately 87 percent of the firm's total assets. Additionally, inventory and prepaid expenses account for approximately 23 percent of total assets. The company's cash position is exceptionally strong (approximately 39 percent of total assets).
Your are correct, however, in your assumption that bankers, when considering a business expansion loan for Aunt Connie's Cookies, also will want to be provided with sufficient information to allow them to evaluate the future financial performance of the business. You have asked about the possibility of including firm orders amounting to $100,000 for the coming six months in the firm's income statement covering the just completed financial reporting period.
Including the $100,000 in firm future orders for the coming six months in the income statement for the recently completed reporting period would not be in accordance with generally accepted accounting procedures. The Financial Accounting Standards Board (1984) requires the recognition of income in the period in which the income is earned. This approach assures that income is not reported before it is earned. The value of a firm order is not earned until the product covered in a firm order is transferred from the seller to the buyer (Financial Accounting Standards Board, 2004). Additionally, waiting to include revenue until it is earned also better assures that revenues will be matched with the expense items used to earn the revenue.
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