Would accounts receivable be included in the revenue section, along with cash, on the income statement?
BIWSguidestates that accounts receivabledoesn't go on theincome statement, but my understanding was that account receivable is a form of accrued revenue for a business that completed its service/delivered its product, but has invoiced the customer and now is ultimately waiting on getting the cash from the customer. I understand that one of the requirements for an item to be on the income statement is that it must regard transactions happening within the same time period as listed for the income statement, and technically accounts receivable can be fulfilled after this time period. However, I read on a website that under accrual-based accounting, the company is allowed to record the revenue they haven't earned (accrued revenue) but have already done the service to earn it on their income statement. Thus technically, accounts receivable, which is accrued expense but with the invoices sent out to the customer, should be included in the income statement.
I don't know which argument to support, as I can see why accounts recievable can and cannot be in the income statement. If accounts receivable is not included under revenue, then what form of money then does revenue include... only cash?
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Damn this is a good question - halfway through I was like "yeah A/R are assets" but then saw you bring up accrual accounting. I'm interested to see what the responses are
Accounts receivable is a current asset account located on the balance sheet. It will not show up on the income statement. As you correctly implied, under accrual accounting, a company can recognize revenue as soon as it performs the service or sells the good(s), regardless of whether the customer has paid.
If the customer has paid, the journal entry is debit cash for x and credit sales revenue for x. If the customer has not yet paid, the journal entry is debit accounts receivable for x and credit sales revenue for x . As you can see, either way the incremental revenue from said transaction is already recorded and will be reflected on the income statement.
In the case of the latter journal entry, once the cash comes in the subsequent entry is debit cash for x and credit accounts receivable for x. Now the customer has paid, thus lowering the accounts receivable balance while increasing the cash balance by the same amount, both of which are on the balance sheet. There is no need to record revenue because it was already recorded in the prior entry.
Thank you! That makes a lot of sense: Due to the credit/debit nature of Accounts Receivable/Cash and Sales revenue, it technically is already recorded within revenue but is not specifically outlined on the income statement as a separate line to prevent double counting, correct? I want to make sure I am understanding that correctly.
Hopefully I wouldn't need to go this in depth inmyIBinterviewshaha Also, I had another technical question that I mind as well just throw here if you don't mind answering that as well. It deals with cash flow from operations.
Cash flow from operations is calculated as: Net income + D&A - Taxes + change in working capital. Change in working capital is calculated via changes in current assets and liabilities of the current period from a previous period. If a company were to get cash upfront for the services it provides, how would this result in a negative working capital for a company and inherently a loss in net cash> Cash is a current asset. Cash increases but inventory, also a current asset, decreases. Thus. there is a no change in working capital between this current time period and the previous, ultimately leaving CFO to be unaffected.
BIWS states that such companies, like McDonalds, who receive cash upfront result in having negative working capitals and ultimately causes CFO to decrease.
Sorry to bug you with questions, but I found your last response super helpful! Appreciate the help
Yes, due to the nature of the accounting entries, any increase in accounts receivable induced by sales revenue is already included in theincome statement via收入线项目。如果你把balance sheet account like accounts receivable on the income statement you would be double counting.
The formula for cash flow from operations (using the indirect method) isnet income+ depreciation - change in net working capital. Depreciation is added back because it's a non-cash expense that was previously subtracted in the income statement during the net income calculation. Change in net working capital is subtracted because if you were to have a positive change, you now have to fund the excess current assets with cash outflow while if you were to have a negative change, your excess current liabilities will result in a cash inflow.
When companies receive cash upfront prior to performance of service / sale of good(s), the journal entry is debit cash for x andcredit unearned revenuefor x. Logically, cash would increase, meaning that cash flow from operations could not be simultaneously decreasing. This is reflected on the cash flow statement in the following manner: change in net working capital has decreased by x due to the unearned revenue being credited for x (note that cash is not included in the change in net working capital because the formula used in the cash flow from operations section is change in non-cash current assets - change in non-debt current liabilities). As a result, the negative change in net working capital of x is added back (a negative and a negative makes a positive), meaning that cash flow from operations has increased by x. This is exactly what we wanted to see because as a result of the aforementioned journal entry, the cash balance had increased by x.
If I'm understanding your question correctly, I think you're maybe confusing revenues with cash. Without getting into the weeds of accounting, there are 4 criteria (I think - maybe 5) that must be met in order for revenue to be considered "recognized", one of which is when goods/service delivery is "substantially complete", which you alluded to. A company may record a "sale", but cash doesn't always come in right away. In most cases, there's a 30-60 day lag between the sale and when the cash comes in (think credit cards, etc.). Under accrual accounting, companies are supposed to take into consideration the fact that not all sales will result in cash by estimating an "allowance for doubtful accounts", which is a contra-asset to A/R.
Revenue doesn't represent any real form of "money" in the traditional sense, which is also why investors are typically focused on the cash/earnings power of the business. Consider a construction project where a customer pays in installments a certain amount of cash every quarter for a project that takes 2-3 years. Under accounting rules, revenue will be recognized ratably based on the estimated costs of completion and the amount of cost incurred each period (if you're a masochist/bored, read about "percentage of completion" accounting). However, from a cash perspective, the company is only receiving cash every month/quarter based on the contract. Accounting works this way to smooth out revenue and provide more useful info to investors (i.e. it'd be annoying if the company only got paid upon completion of this project and therefor had $0 revenue in Y1/2, but $10M or something in Y3). That said, "revenue" as far as accounting doesn't correlate 1:1 with any "money" in the traditional sense.
Hope that helps a bit
Only once have I ever seen a company distinguish between what you seem to be referring to. Revenue is money made, simply put, i.e. the INCOME that a company gets, whether that be through cash, credit, gold, Jolly Ranchers, etc. it's the currencyrepresentation of what is being RECIEVED by the company. This seems like a stupid thing to say on an IB board, but it is important to contextualize.
If we are being descriptive and detailed (seldom done in finance), companiesshoulddistinguish between credit revenue and debit (cash, debit card, etc. non credit revenue) revenue. I have seen ONE company in my entire life, among thousands of them, distinguish between their credit revenue and their hard, debit revenue. What's funny here is that a trader or ER analyst could get some great insight into the company's operations from this relatively simple distinction because it would reveal a world about the company's credit management and their credit cyclicality as it relates to their customers and the company's structure. The reality is that it's better for investors to justnot knowabout how late some companies get their 'revenue' from their customers to actually land in their accounts. Like a few other colleagues have mentioned, it usually takes 30 to 60 days for some to land, butif the SECwere to force companies to start distinguishing explicitly how much of a company's revenue is credit and how much comes from debit (which the debit would likely be very, very low anyway), many companies would see their premiums drop.
On the other hand, this is partially accounted for through contra assets (doubtful accounts, i.e. we know that a CERTAIN percentage of this credit isn't going to be fulfilled and hence we control for that with this quantity of money as insurance).
Dalio explanation of the macroeconomic machine puts it best, like 95%+ of the world's money is in credit, so none of this matters in the grand scope of thingsanyway.
Good Q, but the answer is very simple.
Say a company sells a product for £100.
At the time of selling the product:
At the time the money is received:
So, yes, theARbalance will include money that has already been recognised in revenue at the time the product is sold. ThisARasset balance on the B/S will transfer to cash balance once cash is received. Revenue was recognised at the point of sale.
Note, this is a simplistic example based on a traditional product focused company.
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