MAB1033 Phillips Chapter 3 Income statement 2

Which of the following situations results in deferred revenue?

• Collected $100 from a customer who purchased goods a month ago.

• Received an order from a customer who will purchase and pay for goods in two weeks.

• Sold goods for $100 today with payment due from the customer in 30 days.

• Received $100 cash from a customer for an order of goods to be shipped next month.

Answer explanation

Deferred revenue is a liability representing a company's obligation to provide goods or services to customers in the future. Accordingly, the receipt of $100 cash from a customer for an order of goods to be shipped next month is deferred revenue.

When cash is received in advance of a performance obligation being satisfied, a(n) ________ called ________ is recorded.

• liability; Deferred Revenue

• asset; Deferred Revenue

• liability; Accounts Receivable

• asset; Accounts Receivable

Answer explanation

Deferred Revenue is a liability representing a company's obligation to provide goods or services to customers in the future.

Deferred Revenue is a(n):

• expense.

• asset.

• revenue.

• liability.

Answer explanation

Deferred Revenue is a liability representing a company's obligation to provide goods or services to customers in the future.

If the cash is received before the related goods or services are delivered, which of the following will be recorded?

• Deferred Revenue, a liability.

• Accounts Receivable, an asset.

• Pre-earned Revenue, which increases Retained Earnings.

• Service Revenue, which increases Retained Earnings.

Answer explanation

When cash is received before the related goods or services are delivered, the company is obligated to provide goods or services to customers in the future. That obligation is a liability called Deferred Revenue.

Time Warner is a publishing and communications company, specializing in magazines, cable television operations, television program development, and other telecommunication services. Its financial statements show $37,666 in an account called Deferred Revenue, which represents amounts that customers have paid in advance of receiving magazines, cable television, and internet services. What type of account is this and on what statement is it reported?

• Asset; Balance Sheet

• Liability; Balance Sheet

• Revenue; Balance Sheet

• Revenue; Income Statement

Answer explanation

Deferred Revenue is a liability representing a company's obligation to provide goods or services to customers in the future. Liabilities are reported on the balance sheet.

Which of the following statements about cash basis accounting and accrual basis accounting is correct?

• Using the accrual basis of accounting, if payment is received before delivery of goods or a service, revenue is recorded at the time the payment is received.

• Using the accrual basis of accounting, if payment is received after delivery of goods or a service, an asset is recorded at the time the good or service was delivered.

• Using the cash basis of accounting, if payment is received before delivery of goods or a service, net income is affected when goods or services are delivered.

• Using the cash basis, if payment is received after delivery of goods or a service, deferred revenue is recorded.

Answer explanation

Accrual basis accounting reports revenues when they are earned and expenses when they are incurred. Under accrual basis accounting, if payment is received after delivery of goods or a service, an entry is made to increase Accounts Receivable, an asset, and increase the related revenue account. Cash basis accounting records revenues and expenses when cash is received and paid.

Which of the following statements about cash basis accounting and accrual basis accounting is correct?

• If payment is received at the same time a service is provided, it does not matter whether cash basis accounting or accrual basis accounting is used; both would record the transaction with the same journal entry.

• The cash basis of accounting works best when a lengthy delay exists between the timing of cash flows and the underlying business activities to which they relate.

• If a company receives a bill for rent for the period and decides to delay payment, the rent will not be recorded as an expense if accrual basis accounting is used.

• If the cash basis of accounting is used, the Deferred Revenue account is increased when a company receives a deposit in advance of services to be performed by the company.

Answer explanation

Cash basis accounting records revenues and expenses when cash is received and paid. Accrual basis accounting reports revenues when the performance obligations are satisfied and expenses when they are incurred. As a result, if payment is received at the same time a service is provided, it does not matter whether cash basis accounting or accrual basis accounting is used; both would record the transaction with the same journal entry.

Which of the following statements about accrual basis accounting is correct?

• If a company uses accrual basis accounting, the company should not record revenue until payments are actually received.

• If a company uses accrual basis accounting, the company should record expenses in the same period as the revenues they generate.

• IFRS does not allow accrual basis accounting for external reporting of income.

• The items reported on the income statement continue to have an impact beyond the current period, whereas the items reported on the balance sheet impact just the current period.

Answer explanation

The expense recognition principle ("matching") requires the recording of expenses in the same period as the revenues they generate, not necessarily the period in which cash is paid for them. According to GAAP and IFRS, the accrual basis is the only acceptable method for external reporting of income. The revenue recognition principle requires a seller to record revenue when the seller provides the goods or services to customers, in the amount the seller expects to be entitled to receive. Items reported on the balance sheet items (rather income statement items) continue to have an impact beyond the current period; whereas items reported on the income statement (rather than balance sheet items) impact just the current period.

The Fastbank Motorcycle Service Company wins a $10 million bid to provide the repair services for a recall on a popular brand of motorcycles. No money is exchanged. The repair services are expected to be performed early next year. Which of the steps of the five-step model for revenue recognition is not yet complete?

• Determine the transaction price.

• Identify the seller's performance obligation(s).

• Identify the contract.

• Recognize revenue when (or as) each performance obligation is satisfied.

Answer explanation

No services have yet been provided, revenue will only be recognized when goods are delivered or services provided.

During June, the Grass Is Greener Company mows 100 lawns a week; the company bills customers and full payment is due by July 15. The company uses the accrual basis of accounting. How will these events affect the company's financial statements?

• In June, an asset and a liability account will both increase.

• In June, an asset and a revenue account will both increase.

• In July, an asset account will increase and a liability account will decrease.

• In July, a liability account will decrease and a revenue account will increase.

Answer explanation

When a sale occurs or a service is provided before cash is received, an asset account (Accounts Receivable) increases and a revenue account (Service Revenue) increases at the time the sale occurs or the service is provided. At a later date, when cash is received, an asset account (Cash) will increase and another asset account (Accounts Receivable) will decrease.