If a firm recognises sale when orders are received (and in some cases Bill and hold) can you please explain why Net Income is overstated and ending inventory is understated?
Also how is COGS impacted through the above revenue recognition.
Thanks
Recognizing revenue early will increase your net income early, therefore overstated
Where are you reading the effect on inventory?
I thought that might be the case, a higher revenue is a higher top line figure so larger net income, the reason I asked was because I was not sure how the COGS might be impacted.
It is from Q80 in schweser mock 3 afternoon session (p168)
If they recognize it as revenue I assume they must take it out of inventory and enter under AR on the balance sheet. So inventory will be understated.
Normally if bill and hold you are not allowed to call it revenue because you (the seller) still physically the goods and have not delivered to your customer.
(Strangely under some jurisdictions, where I live, it is allowed for companies).
If we take it out of Inventory are we assuming your COGS increases despite not actually releasing the product yet?
Account Receivable 100
Sales 100
COGS 75
Inventory 75
NI would be overstated because [Sales - COGS = Gross Profit] would be overstated
Ending inventory would be understated because you have not shipped yet