Chapter 3: Problem 12
Adjustments for accrued revenues: a. have a liabilities and revenues account relationship. b. have an assets and revenues account relationship. c. decrease assets and revenues. d. decrease liabilities and increase revenues.
Short Answer
Expert verified
The correct answer is b: have an assets and revenues account relationship.
Step by step solution
01
Understanding Accrued Revenues
Accrued revenues are earnings that have been recognized but not yet received in cash. They are recorded when a company has delivered products or performed services but has not yet received payment.
02
Identifying Account Relationships
Accrued revenues have a relationship between the accounts involved. When accrued revenues are recorded, they are recognized as an increase in revenues and an increase in assets, typically accounts receivable.
03
Evaluating Provided Options
We examine each option:
- Option a suggests a liabilities and revenues relationship, which does not occur in accrued revenues.
- Option b suggests an assets and revenues relationship, which aligns with the definition of accrued revenues.
- Option c suggests decreasing assets and revenues, which is contrary to the nature of accrued revenues as they increase these.
- Option d suggests decreasing liabilities and increasing revenues, which does not accurately describe accrued revenues.
04
Selecting the Correct Option
Based on our evaluation, option b is correct as it reflects the assets and revenues relationship that is characteristic of accrued revenues.
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Key Concepts
These are the key concepts you need to understand to accurately answer the question.
Assets and Revenues Relationship
In the world of accounting, understanding the relationship between assets and revenues is crucial when talking about accrued revenues. Accrued revenues occur when a company delivers a product or delivers a service but hasn't yet received payment from the customer. This situation creates a specific relationship between assets and revenues.
When a company recognizes earned revenues that haven't yet been paid, two main accounts in its financial records are affected:
When a company recognizes earned revenues that haven't yet been paid, two main accounts in its financial records are affected:
- Assets: The concept of accrued revenues shows an increase in a company's assets. The specific asset account impacted is called "Accounts Receivable." This represents the amount of money owed to the company by its customers for the goods/services delivered. This increase is because the company is owed funds.
- Revenues: Even though payment is not yet received, the company has earned the revenue through providing a service or product. Hence, revenues are recorded to show the increase in earnings at the time the service is performed or the product is delivered.
Accounts Receivable
Accounts receivable is a fundamental element in the financial statements of businesses that practice accrual accounting, like those with accrued revenues. But what exactly is "accounts receivable," and why is it important?
- Definition: Accounts receivable refers to the money that is owed to a company by its customers after the company has delivered goods or services but hasn't yet received payment. It's an asset because it represents a future inflow of cash.
- Impact on Financial Health: Having a high accounts receivable indicates that a company has extended credit to its customers. While having some accounts receivable is normal, too high a balance might suggest challenges in collecting payments.
- Connection to Accrued Revenues: In the context of accrued revenues, accounts receivable reflects recognized earned income awaiting receipt. This is why accounts receivable increases when accrued revenues are recorded, thereby boosting the value of a company’s assets until the payments are collected.
Earnings Recognition
Earnings recognition is the accounting practice used to determine when to record revenues and expenses in the books. Let's explore this concept in the context of accrued revenues.
With accrued revenues, earnings are recognized before cash is received. This is a key component of the accrual basis of accounting and ensures that the financial statements reflect the company's actual performance for a given period. Here's how it usually works:
With accrued revenues, earnings are recognized before cash is received. This is a key component of the accrual basis of accounting and ensures that the financial statements reflect the company's actual performance for a given period. Here's how it usually works:
- Revenue Recognition Principle: This principle states that revenue is recorded when it is earned, not necessarily when cash is received. This can happen before, during, or after the actual inflow of cash.
- Matching Principle: Alongside revenue recognition, this principle dictates that expenses should be matched with the revenues they help to generate within the same reporting period, ensuring an accurate picture of a company’s profitability.
- Impact of Timing: Recognizing earnings at the right time allows businesses to align their income and expenses accurately, showing a real-time financial status. This is particularly important for accrued revenues as it impacts how stakeholders view the business’s financial health.