Question #9
Reading: Reading 12 Evaluating Quality of Financial Reports
PDF File: Reading 12 Evaluating Quality of Financial Reports.pdf
Page: 8
Status: Incorrect
Correct Answer: A
Your Answer: B
Question
A manufacturing firm purchases equipment for use in its operations. With regard to recording the purchase using the cash basis versus the accrual basis of accounting, which of the following statements is most appropriate?
Answer Choices:
A. With the cash basis, revenues and expenses relating to the equipment are generally recognized in the same period
B. With the cash basis, revenues and expenses relating to the equipment are generally recognized in different periods
C. With the accrual basis, the cost of the equipment is allocated to the cash flow statements over the asset’s life
Explanation
With the cash basis of accounting, revenues are recognized when cash is collected and
expenses are recognized when cash is paid. Therefore, the cash flows may occur in
different periods than when the revenues are actually earned or when the expenses are
actually incurred. For example, the purchase of equipment used in a firm's manufacturing
operation may result in an immediate cash outflow but the equipment generates revenues
over its useful life. In this case, the revenues and expense are reported in different
periods.
With the accrual basis of accounting, revenues are recognized when earned and expenses
are recognized when incurred, regardless of the timing of the cash flows. With the
equipment purchase, the cost of the equipment will be allocated to the income statement
(not cash flow statement) over the asset's life and at the same time, matched with the
revenues generated.