The reporting of revenue inflows, and the timing of other transactions, must abide by accounting principles that govern financial statements. Revenue recognition, for example, is the formal recording and reporting of revenues at the appropriate time. Although a firm earns revenues continuously as it makes sales, earnings are not reported until the earnings cycle is completed. This cycle is complete under two conditions:

1. The sale is complete and the product delivered.

2. The sale price has been collected or is collectible (accounts receivable).

The end of the earnings cycle determines the timing for revenue recognition in a firm’s financial statements. Suppose a toy company in January signs a sales contract to supply $1,000 of toys to a retail store with delivery scheduled in February. Although the sale is completed in January, the $1,000 revenue should not then be recognized (that is, not be reported in the firm’s financial statements) because the toys have not been delivered and the sale price is not yet collectible, so the earnings cycle is incomplete. Revenues are recorded in the accounting period—February—in which the product is delivered and collectible (or collected). This practice ensures that the statement gives a fair comparison of what was gained (revenues) in return for the resources that were given up (cost of materials, labor, and other production and delivery expenses) for the transaction.

To help users better understand the numbers in a firm’s financial statements, GAAP requires that financial statements also include management’s interpretations and explanations of those numbers. The idea of requiring input from the manager is known as the full disclosure principle. Because they know about events inside the company, managers prepare additional information to explain certain events or transactions or to disclose the circumstances behind certain results.

For example, Borders was once the second-largest bookseller in the United States (behind Barnes and Noble). However, the firm filed for bankruptcy in early 2011 and closed its last store in September of that same year. In its annual reports and financial statements beginning as early as 2008, however, the management of Borders had discussed the competitive and economic risks facing the company. These disclosures noted that consumer spending trends were shifting to online retailers and eBooks and away from in-store purchasing, thus posing growing risks for Borders’ cash flows and overall financial condition. Management’s discussion noted there could be no assurance that Borders would muster adequate financial resources to remain competitive and, indeed, it soon happened. On filing for bankruptcy, Borders’ liabilities of $1.29 billion had surpassed its assets of $1.28 billion.²⁰ The disclosure information helped investors and other stakeholders make informed decisions about the risks associated with investing in or doing business with Borders. It would have been a far different story had Borders’ managers offered deceptively optimistic assessments of the business’s future.