A business earns income by converting assets and resources into other assets and resources. For example, through the efforts of its workforce and other resources, a business converts inventories of raw materials into receivables and cash. The value of the new assets generated may be termed “revenue,” that of the assets and resources consumed may be termed “expense,” and the increased value may be termed “income.” Therefore, it can be argued that asset valuation, revenue recognition, and matching of expenses to revenues are interrelated. Some of these relationships are:
a. The choice of asset valuation method affects revenue recognition.
b. The theory on which revenue generation is based affects the valuation of the related assets.
c. When the objectives of asset valuation and income recognition conflict, it becomes necessary' to choose either the desired asset valuation method or the desired income recognition method.
Required:
Discuss each of the three relationships described above and provide examples where appropriate.