What accounting principle requires revenue to be reported when earned?

Answer 1

In GAAP there are two basic accounting principles. The first being Accrual (which is the most commonly used) and the second being Cash Basis.

Neither stipulate that income has to be "earned" before it is reported. The difference in the two are:

Accrual basis accounting transactions are reported as they happen.

1. For example, a contractor gets paid to remodel a home, he's received the money for the job, but hasn't earned it, completed the work. Accrual account states that this transaction be recorded as a liability (unearned revenue) to the company until the revenue is earned.

2. Say the opposite is true in accrual accounting, the contractor finished the remodeling but isn't expected to be paid for it until later in the future. The company records this transaction as an asset (account receivable).

Now let's look at Cash Basis: Cash basis states that a transaction didn't actually happen until such time the money is received, period. Take example 1, a transaction in cash basis accounting is recorded because money was actually received, even though it hasn't been earned.

Example number 2 however, would be no recording of the transaction, although the job was finished, no money exchanged hands as of yet.

This is why many businesses use accrual accounting. Only small companies that generally deal in cash or small amounts tend to lean toward cash basis accounting and it is still not recognized as a very good method of accounting by the GAAP.