Question ID#: 98033 When a firm recognizes revenue in excess of expenses on a product not covered by a warranty before cash is collected, what is the impact on the firm’s assets and liabilities, ignoring taxes? Assets Liabilities A) Increase No effect B) Increase Increase C) No effect Increase Your answer: C was incorrect. The correct answer was A) Increase No effect When a firm recognizes revenue before cash is collected, equity increases (retained earnings) and assets increase (accounts receivable). Liabilities would not be affected. My solution was that when we recognise unearned revenue, we pass entry as Cash A/c Dr. ----- To Unearned Revenue A/c So, Asset increase and Liability increase . I think that equity will remain unaffected since we will not show the unearned revenue in calculating net profit, so retained earnings(hence equity) should remain unaffected. Can anyone confirm this?
you are correct about USR: you would do: A/R xx USR xx BUT, in this problem they tell you that they recognize revenue, before cash is received. so you know you have to use revenue account, not USR, and you know to use the A/r since it is before cash is received. Unearned service revenue is a liability, so there would be no revenue recognized if you use that account, but the problem says they did recognize the revenue. you the journal entrey would be: A/R xx Revenue xx equity up, assets up, liabilities unchanged
my approach is entirely different from the two approaches above, they dont really make sense to me. this is how i think about it. a typical scenario involving “a product without warranty” would be a company has sold a good and recieved cash. so inventory would go down, cash/Acc recievable would increase at a greater rate depending on whether the sales was credit. so a net cash inflow that result in increase in asset. and there is no cash out flow, so no provision for warranty. the part i dont understand is why are people talking about unearned revenue here. inventory goes down, account recievable goes up, it means the revenue has realised, just not yet recieved. is this right ?
Okay Starbuk, i can see where i went wrong now. Question was not asking for ’ unearned revenue" , but was saying that revenue is already earned , though cash collection is pending. So, accounts recievable a/c dr and P&L A/c cr It will be an unearned revenue when Cash is already collected in advance but income is not due to me., which is not the case here. eg. When a plumber gets money in advance , for doing some work say, next month, then he will pass entry as cash a/c dr to unearned revenue. Izen , i made you confused unnecessarily. Sory. 
.Hope you got my mistake. I wrongly thought the cash is already recieved