CFA Practice Question
Under accrual accounting, which of the following is (are) correct?
II. Expenses do not always involve cash flows.
III. Revenues and the related costs are matched in the same period.
IV. The reported income is a good indicator of the firm's current performance.
I. Revenues are recognized when cash is received.
II. Expenses do not always involve cash flows.
III. Revenues and the related costs are matched in the same period.
IV. The reported income is a good indicator of the firm's current performance.
A. II, III & IV
B. I, II, III & IV
C. I & III
Explanation: Accrual accounting requires that revenues and gains be recognized when earned and expenses and losses be recognized when incurred. Hence, revenue recognition is completely separate from cash flows. In the sales process, the earnings process is completed when goods are delivered and that's when revenue is recognized under accrual accounting.
User Contributed Comments 2
| User | Comment |
|---|---|
| Kuki | just for clarification...is IV correct because the revenue is recognised when the goods are delivered? if yes..then doesn't a cash accounting system give a better indication about the firms current performance? |
| GBolt93 | NI matches revenues with their expenses. Cash accounting doesn't. Imagine you sell a 20 year warranty for 100, which will cost you $4 a year. Under cash accounting you have made $96 profit your first year. Really though you only made $1, but you got paid upfront. Cash can severely skew actual performance. Where as accrual matches revenues with what it actually cost to make that revenue. |