The Daily Technical #85: What is the relationship between return on assets (ROA) and return on equity (ROE)?

Good morning. Welcome to the 85th edition of The Daily Technical.

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OVERVIEW OF YESTERDAY’S QUESTION
Tell me about the revenue recognition and matching principle used in accrual accounting.

In accrual accounting, two core principles guide financial reporting: revenue recognition and the matching principle.

First, the Revenue Recognition Principle states that revenue is recorded when a good or service is delivered and earned, regardless of when payment is received. This ensures that revenue accurately reflects the company's performance during the specific period in which the transaction occurs.

Second, the Matching Principle ensures expenses related to producing or delivering a good or service are recorded in the same period as the revenue they generate. This alignment provides a clear picture of profitability for that period by accurately matching costs with their associated revenues.

These principles ensure consistency and clarity in financial statements, giving a genuine snapshot of a company’s financial activity within a given timeframe.

Common Mistakes

1. Confusing when to record revenue, thinking it's recorded only when cash is received. Remember, revenue is recognized when goods or services are delivered, regardless of payment status.

2. Assuming expenses should always align with cash flow. Ensure expenses are recorded in the same period as the related revenue, not when the cash is spent.

TL;DR

• Revenue Recognition: Record revenue upon delivery of goods/services, irrespective of payment receipt.

• Matching Principle: Log expenses when associated revenue is earned, aligning costs with income.

• These principles ensure consistence and clarity in financial statements.

TODAY’S QUESTION
What is the relationship between return on assets (ROA) and return on equity (ROE)?

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THAT’S A WRAP
See you tomorrow,

Mike Lukasevicz
Founder @ HirePrep