Why must amounts received in advance from customers be deferred in the accounting records?

• A. Because it is required to match expenses with revenues in the same period, even if the service has not been performed.
• B. Because the revenue has not yet been earned and should be recognized only when the related goods or services are provided.
• C. Because all cash received must be immediately recorded as revenue, regardless of when the service is performed.
• D. Because deferring revenue increases net income in the current period.

Answer: (B)

Verified step by step guidance

1. Understand the concept of revenue recognition: Revenue should only be recognized when it is earned, meaning the goods or services have been provided to the customer.
2. Identify the principle of matching expenses with revenues: This principle ensures that revenues and related expenses are recorded in the same accounting period to accurately reflect financial performance.
3. Recognize the role of unearned revenue: Amounts received in advance from customers are considered liabilities (unearned revenue) because the company has an obligation to deliver goods or services in the future.
4. Record the advance payment correctly: When cash is received in advance, it should be recorded as a liability under 'Unearned Revenue' or 'Deferred Revenue' on the balance sheet, not as revenue on the income statement.
5. Adjust the accounting records when the service is performed: Once the goods or services are provided, the liability is reduced, and the revenue is recognized in the income statement, ensuring compliance with the revenue recognition principle.