A company receives $10,000 in cash for services yet to be performed. Using the accrual method, what’s the correct entry to record the transaction?
A. Debit cash$10,000, credit accounts receivable $10,000
B. Debit cash$10,000, credit sales revenue$1 0,000
C. Debit sales revenue$10,000, credit cash $10,000
D. Debit cash$10,000, credit unearned revenue $10,000
E. Debit cash$10,000, credit accounts payable $10,000
The Correct Answer and Explanation is :
The correct entry to record the transaction is:
D. Debit cash $10,000, credit unearned revenue $10,000.
Explanation
When a company receives cash for services that have yet to be performed, it must recognize that the revenue has not yet been earned under the accrual accounting method. Accrual accounting dictates that revenue should only be recognized when it is earned, regardless of when cash is received.
In this scenario, the company received $10,000 in cash, but since the services are still pending, this transaction cannot be recorded as revenue. Instead, it creates a liability for the company, as it has an obligation to provide services in the future. This liability is recognized as “unearned revenue” (or deferred revenue) on the balance sheet.
The journal entry for this transaction involves debiting cash to reflect the increase in cash assets and crediting unearned revenue to acknowledge the liability. Here’s a breakdown of the journal entry:
- Debit Cash: This entry increases the cash account by $10,000, reflecting the cash the company has received.
- Credit Unearned Revenue: This entry increases the unearned revenue account by $10,000, signifying that the company owes services to its customers in the future. It indicates a future obligation to deliver services, and until the services are performed, this amount cannot be recognized as revenue in the income statement.
Once the company completes the services, it will then make an adjusting entry to recognize the revenue. This entry would involve debiting unearned revenue and crediting sales revenue, thus ensuring that revenue recognition aligns with the services provided, consistent with the accrual basis of accounting.
In summary, option D accurately reflects the proper accounting treatment for cash received in advance of service delivery, ensuring compliance with accrual accounting principles.