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What is the revenue recognition principle? What is the expense recognition principle? Why are they important to financial reporting?

The revenue recognition principle makes it so that the revenue a company earns is recorded in the same accounting period in which the product or service was sold.  The expense recognition principle says that the expense will follow the revenue.  Basically, whatever money was spent in producing the revenue will be accounted for in the same period as the revenue earned.  Most argue that the principles, if followed, will show a more accurate state of being for the company.  Others argue that it makes the statements harder to read and that cash basis accounting is better.

The revenue recognition principle is the process where a company records any financial event in the accounting period that it is earned. When a service is performed or a product is ordered it is listed as revenue in the period that the action of the event took place regardless of when the actual payment for the service or product is received.
The expense recognition principle simply lets the expenses follow the revenues. Revenue recognition and expense recognition work together to provide the actionable events of a given accounting period. When expenses make their contribution to revenues is the point when expense recognition takes place, regardless of when the expense is paid. This is also known as the matching principle which shows that efforts are equal to results.

These principles are important to a financial reporting period because it stops a company from overstating revenues and instead requires them to show expenses in a realistic and time applied manner. When an applied to a cash-basis accounting process the picture may look simpler to understand but it can be misleading to investors because the expense can be shown in a later quarter which makes the company look healthier than it is in reality.

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