Hi everyone,
I can work out the questions at the end of the chapter but I am not sure I completely understand the underlyings.
Revenue Recognition issue: (red flags)
From what I understand we are trying to understand where the revenues come from. Cash is king (sign of good quality earnings) so we need to understand how much of the revenue is cash.
So we should look out for
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large increase Account receivable , it means we are recognizing revenue but we have not received the cash for it (accrual based method). in addition to the increase in Account receivable we check if there is any write off , which would increase the amount of cash that won’t be collected.
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Large decrease in unearned/deferred revenue, It means we have received cash but not yet recognized the revenue as it is not earned. Management can play with that account to boost the reported revenue when they need to. So if they push revenue out of unearned revenue into reported revenue that would be another warning sign.
Consequently:
Revenue = Cash collected from customers
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(increase in A/R + Possible write off)
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(decrease in Unearned revenue)
Is that right ? I am confused
the other formula I had committed to memory was:
Cash collected from customers = Revenue - increase in act Receivable + increased in unearned/deferred revenue.
if this is clear for you, could you help me make sure I got this right or wrong ? thanks for your time.