Multiple Choice
Receiving cash from customers before services are performed affects which of the following accounts?
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3. Accrual Accounting Concepts
Adjusting Entries: Unearned Revenue
Multiple Choice
Why must amounts received in advance from customers be deferred in the accounting records?
A
Because it is required to match expenses with revenues in the same period, even if the service has not been performed.
B
Because the revenue has not yet been earned and should be recognized only when the related goods or services are provided.
C
Because all cash received must be immediately recorded as revenue, regardless of when the service is performed.
D
Because deferring revenue increases net income in the current period.
Verified step by step guidance1
Understand the concept of revenue recognition: Revenue should only be recognized when it is earned, meaning the goods or services have been provided to the customer.
Identify the principle of matching expenses with revenues: This principle ensures that revenues and related expenses are recorded in the same accounting period to accurately reflect financial performance.
Recognize the role of unearned revenue: Amounts received in advance from customers are considered liabilities (unearned revenue) because the company has an obligation to deliver goods or services in the future.
Record the advance payment correctly: When cash is received in advance, it should be recorded as a liability under 'Unearned Revenue' or 'Deferred Revenue' on the balance sheet, not as revenue on the income statement.
Adjust the accounting records when the service is performed: Once the goods or services are provided, the liability is reduced, and the revenue is recognized in the income statement, ensuring compliance with the revenue recognition principle.
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