Hi, I just have a real quick accrual accounting question. So accrual accounting recognises revenue when the service is provided as apposed to when you are actually paid. So let’s take a simple example, you buy a TV on Credit for £100. So the company who sold you the TV under accrual accounting would: Recognise £100 in acounts receivables and sales Then eventually when you pay them A/R gets reduced by £100 and cash increases by £100 My question is that I have read that high acrual revenue is not sustainable in the long run as it must reverse at some point leading to lower future NI. Why is that?
my way of looking at the above statement… in this example - say the company had 200$ in Credit card sales - its income statement would show 200$ as Revenue and say NI of 100$ for the purposes of illustration. Year 2- say 100$ in Credit Sales - again 50$ Net Income. Up until now - only Sales have been Credit Sales - (accrual revenue) and all that has already been recognized as Income. What you have gotten as cash - is coming much later. Say Period 3 was a very poor period (economic downturn and all that) and no more Sales occurred… Would you have any Net Income?
Hey CPK, I remember you from all your answers to my L1 posts last year. Thanks for the answer so you are basically saying that a company cannot generate accrual revenue for a long period of time because at some point in time they will experience poor sales?? And if you compare this to cash accounting then even in periods of bad sales you will still be recogising revenue from previous sales. Is that correct??
I think that is kind of what the authors are implying in the reading. Accrual based revenues are short term. Not sustainable…
Perfect, cheers!