Profit arises only out of business operation when there is an increase in the owner's share of the business and not due to his contribution to the business. Any increase in owner's equity is called revenue and any reduction in it termed as a loan. In fact, it is the direct outcome of Realization Concept (already discussed) and the Accounting Period concept. In a way, realization concept has been split up into two parts, namely, production of economic goods or rendering of economic services, and realization of due revenue. Any uncertainty about any of the two elements beyond what is considered uncontrollable will not permit the accountant to treat the money value or cash equivalent of the sale price to be considered as realized income.
Another very vital element is involved in between, that is, a third one, namely acquiring legal right to claim the price of the goods delivered or fees for services rendered. Acquiring the legal right to claim the consideration for goods/services is called accrual of revenue, which usually precedes collection. However, in case of cash transactions, under the accrual method P/L A/c and Balance Sheet are prepared on the accrual basis, in the absence of any uncertainty about collection. This does not mean that collection has been given less importance than economic value adding and the right to claim the purchase consideration. With uncertainty about collection, it is meaningless and dangerous to take income into account as having been realized. In fact, ability to pay is considered by the supplier of goods and services before one decides to sell his products or render his services to another.
Then after the deal is finalized, goods have been delivered or services rendered and legal right to claim the purchase consideration has been acquired, collection is taken up as a specialized process to ensure return of capital and earning of profit. The other pressure comes from the Accounting Period...
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