A company makes a credit sale for $500. Future collection from the customer is probable. The company will not record revenue from the transaction until it collects cash from the customer. True or False
The correct answer and explanation is:
The correct answer is False.
Revenue recognition follows the principle outlined in the revenue recognition standard, which states that revenue should be recognized when it is earned, not necessarily when cash is received. This means that a company can record revenue from a credit sale even if it hasn’t yet collected the cash from the customer, as long as future collection is probable.
In this case, the company makes a credit sale for $500. This transaction satisfies the criteria for recognizing revenue because the sale has been made and the goods or services have been delivered to the customer. The key factor here is that future collection is probable, not dependent on immediate cash receipt. The company can therefore recognize the $500 as revenue at the time of the sale.
Under the accrual basis of accounting, which is the standard method used by most companies, revenue is recognized when it is earned and measurable, regardless of when payment is actually received. The matching principle of accrual accounting ensures that expenses are recorded in the same period as the revenue they help generate, providing a more accurate picture of a company’s financial performance.
However, the company will also record an accounts receivable for $500 on its balance sheet. This represents the amount owed by the customer. If, for any reason, collection becomes uncertain, the company may need to adjust the amount of revenue recognized or set up an allowance for doubtful accounts, depending on the circumstances.
To summarize, the company would recognize the revenue from the $500 credit sale immediately, rather than waiting until the cash is collected. This aligns with the accrual basis of accounting, which recognizes revenue when it is earned.