Question

Why must amounts received in advance from customers be deferred?

a. The customer may not pay the entire balance due

b. The company receiving payment has not earned the amount

c. The customer has a right of return

d. All of the above are reasons to defer

Answer 1

Basically the way the question is worded is slightly confusing but what it means to ask is why should we defer recognizing the revenue on receipt of an advance payment from a customer. Options given here also imply as follows:

a. The customer may not pay the entire balance due: This means that if we recognize the entire sales as revenue, we might end up with a situation that he customer is not in a position to pay the rest of the amount. Therefore revenue should only be recognized when we are reasonably sure that the entire revenue will be received. Receiving an advance not always guarantees the same so recognizing revenue at the receipt of advance is not always a good idea

b. The company receiving payment has not earned the amount: Till the time the company is not sure that it will be able to deliver the good or service against which the advance payment has been made, it should not recognize the advance payment as a revenue

c. The customer has a right of return: Customer might change his mind and return the good, so till the time we are not sure that returns are not possible anymore, recognizing revenue is not prudent. We should be conservative in our approach of recognizing revenue.

As all 3 are valid reasons for deferring revenue recognition, option D which suggests "all of the above" is the right option.