A company performs a service in the current month but will not receive payment for 90 days. Because the company satisfied the performance obligation in the current period, the company records revenue in the current period even though payment will be received in the future.
Revenue Recognition and Realization Principle
The situation described above is a common example of accrual accounting, which is the method of recording financial transactions when they are incurred and not necessarily when cash is received or paid. In this scenario, the company performed a service in the current month and satisfied its performance obligation, meaning that it delivered the service as required to its customer. Because of this, the company is entitled to record revenue in the current period, even if it has not yet received payment for its services.
In terms of accounting principles, recording revenue in this way is consistent with the revenue recognition principle, which states that revenue should be recognized when it is earned, regardless of when payment is received. By recording revenue in the current period, the company is accurately reflecting the financial performance of its business, even if this does not immediately translate into cash inflows.
However, it is important to note that the company may also need to record an accounts receivable entry to reflect the outstanding payment owed by its customer. This entry would represent the amount owed to the company and would be recorded on the balance sheet as an asset. Once payment is received, the accounts receivable entry would be reduced, and the cash received would be recorded as a separate transaction.
Overall, the situation described above demonstrates the importance of accrual accounting and the need to accurately record financial transactions as they are incurred, even if this results in revenue being recognized before payment is received. As a professional tutor, I encourage businesses to adopt best practices in accounting and consult with an accountant or financial advisor as needed to ensure compliance with all relevant standards and regulations.
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