Question

ABC Ltd. receives an advance payment of ₹ 50,000 for goods that will be delivered in the next financial year. The accountant records this amount as revenue in the current financial year. Analyse this action according to the Realisation Principle. What should have been the correct treatment, and how does this impact the financial statements?

Answer 1

The accountant's actions contradict the Realisation Principle of accounting. The Realisation Principle asserts that revenue should be recognised when it is generated, which is usually when things are delivered, or services are given, rather than when payment is received.

In this case, because the products will be delivered in the following fiscal year, the advance payment should be recorded as a liability under “Unearned Revenue” or “Advance from Customers” in the current fiscal year. This liability will be resolved and recognised as revenue in the next fiscal year, when the products are actually delivered.

This advance payment is incorrectly treated as revenue in the current year, thereby inflating the company's revenue and profit for the current fiscal term. This misrepresentation can result in an overstatement of income, potentially misinforming stakeholders about the company's financial situation. Furthermore, it may result in improper tax estimates because taxes will be paid on revenue that has not yet been collected.