![]() ![]() A positive cash flow cannot be reported until year 3 on the company’s financial statements.Īs we can see in this example, two transactions have been spread across a total of three years. This means it can be recognized as revenue on the income statement (the product was delivered to the customer), but can not be reported in the cash flow statement as no cash has been received. Even though the product was sold in year 2, it was sold on credit so no cash is received. This will result in a decrease in the cash account and, therefore, a negative cash flow. The materials were purchased using cash in year 1. In year 2, this inventory is then sold resulting in a decrease in the reported inventory balance. Therefore, the company will report an increase in inventory in year 1. Inventory is purchased in the form of materials in year 1. Inventory is a line item on the balance sheet and is affected by this transaction. Therefore, both the revenue and cost of goods sold will be recorded at the time of delivery, in year 2. The COGS must be matched with the associated revenues. The products were delivered to the customer in year 2 so revenue can be recognized during this period. However, the product was not sold until year 2. If we start with year 1, we can see that the materials were purchased with cash. The income statement has two line items which are going to be affected, revenue and cost of goods sold (COGS). In which period will the transactions be recognized in each of the financial statements? Income Statement Cash from the customer is received in Year 3. They are sold on credit and delivered to the customer in Year 2. Materials are bought with cash in Year 1. Expenses are matched with revenues for the period using the accruals concept.Revenue recognition is an accounting principle which looks at when revenue can be recognized in an accounting period (typically when the revenues is earned and when the product or service has been delivered).The income statement is built on the accruals concept which means sales and expenses are recognized in the period in which they are generated. ![]()
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