Question

Discussion: At the beginning of the chapter, there is a short paragraph about the Financial service firm, Deloitte Touche Tohmatsu Limited (Deloitte). Let's read this together. .. Question: Careful recordkeeping is critical to all businesses, large and small. Why does matching these revenues and expenses within the same year, matter so much? Please click on the Reply link below, and post your answer. * To receipt the full credit, the following criteria must be met: A two-paragraph specific and thoughtful response to this topic; and

Answer 1

Let us start this by assuming a few things.

First, let us assume that you own a business. Nothing large, just a small Mart. You sell retail goods and are famous in your area.

Second, let us assume I am a banker and you have come to me to obtain a loan to expand your business.

We are both having a look at your financials. I cannot offer you a loan without looking at the financial metrics. When I see your financials of the past 5 years I try to make a trend but I cannot find any.

In Year 5 you have a huge profit of $ 200,000 whereas in Year 4 it is only $ 70,000. In Year 3 it was a loss of $ 100,000. In Year 2 you were merely at breakeven and in Year 1 you had an income of $ 90,000.

Looking at these figures I look perplexed. I offer you a chance to explain. This is the explanation that I receive

-To earn income in Year 1, there were certain purchases amounting to $ 60,000 which were booked and paid in Year 2.
-In Year 2 towards the end there were certain expenses incurred for Year 3.
-In Year 3 a large amount of goods were purchased and instead of recording inventory, all were recorded as an expense.
-In Year 4 many expenses for Year 5 were recorded.
-In Year 5 the profits are huge because most expenses were booked in Year 3 and Year 4.

Do you see this? The expenses in the business were not matching the revenue. The revenue of a certain period was matched with expenses of another period.

There are no patterns. The operations do not make much sense. Looking at the profit figures no trend can be analysed.

The true result can only be assessed if the revenues of the business are matched with expenses for the same period. Only then the true profitability can be measured.