- A. Money the company owes
- B. Money that is owed to the company
- C. Cash flow
- D. Revenue
The correct answer is:
D. Revenue
Why is Revenue the Correct Answer?
In accrual basis accounting, revenue is recognized when it is earned, not when cash is received. This means that businesses need to account for revenue when a service is provided or a product is delivered, even if the cash payment hasn’t been received yet. This approach is different from cash basis accounting, which only recognizes revenue when the actual cash transaction occurs.
Explanation with Example:
- Revenue Recognition (Accrual Basis):
Let’s say your company provides a service in December, and the client agrees to pay in January. Under accrual accounting, you would recognize the revenue in December, even though no cash has been received yet. This gives a true representation of the company’s financial performance during the period it occurred, rather than when the money arrives. - Why Special Attention to Revenue?
Accrual accounting requires businesses to track uncollected revenue (accounts receivable) and recognize it when it is earned, even before cash is received. This is vital to understanding the company’s financial position because:- It ensures accuracy in reporting, as financial statements reflect the actual earnings of the company, regardless of cash flow.
- It helps in forecasting and financial planning, as you can track both earned revenue and outstanding payments.
- Impact of Revenue on the Financial Statements:
- On the Income Statement, the company reports earned revenue even if it hasn’t received cash yet.
- On the Balance Sheet, the company will show an accounts receivable balance for the amount owed by customers.
Example Scenario:
Imagine a consulting company. In December, the company completes a project and sends an invoice for $5,000, with payment due in January. Even though the company won’t receive the cash until January, under accrual accounting, the $5,000 is recognized as revenue in December, as that’s when the service was provided. The amount is then reflected as accounts receivable on the balance sheet until the payment is received.
