Question

Please write a minimum of 150 words each

6. When is revenue earned and therefore should be recognized?

7. When a company pays $10,000 for insurance that will cover it for two years, the transaction is not immediately recognized as an expense. Explain why.

8. Distinguish between cash flows resulting from operating activities, financing activities, and investing activities.

Answer 1

Answer 6.

Meaning of Revenue :

Revenue means gross inflow of cash, receivables and other consideration arising during the course of ordinary activities of the organization. It arises because of the operating activities undertaken by the organization. Operating activities such as sale of goods, rendering of service, use of enterprise resources by others yielding interest, royalty or dividend etc generate revenue for the enterprise/organization. It is charges made to the customers or clients. In case of an agency, revenue is the amount of commission and  not gross inflow of cash, receivables or other consideration.

Recognition of Revenue :

1. Sale of Goods

Revenue shall be recognized when risk and rewards incidental to ownership are transferred to the other party.It shall be recognized when seller has transferred the goods to the buyer for a consideration.

2. Rendering of Services

Revenue shall be recognized as the services are performed.

3. Other

Interest- Interest shall be recognized on time basis, determined by the amount outstanding and rate applicable.

Royalty- Royalty shall be recognized based on the terms of the relevant agreement.

Dividend- Dividend shall be recognized when right to receive is established.

Answer 7.

Insurance payment by a company of $10,000 that will cover it for 2 years is a case of prepaid expenses.

Prepaid expenses are the expenses for which payment have been made in advance. In this case payment for insurance for the next year has been made today itself. The benefit is such expense is available to the enterprise for more than one year and hence it shall be appropriately distributed over the relevant period.

Out of total expense, the amount of expense that relates to the current period shall be charged to income statement and the remaining amount shall be shown as 'Prepaid Expense' under the head 'Current Assets' in the Balance sheet.

In given case, total expense is of $10,000 the benefit of which will be available for 2 years. Hence expense to be charged in the income statement for the current year shall be $5,000 ( $10,000/2) and remaining amount of $5,000 shall be treated as current asset. This asset shall be charges as expense in the next year.

Answer 8.

Cash flow means the total amount of cash and/or cash equivalents an organization pays or receives during the relevant period. Cash flow analysis is often used to analyse liquidity position of the organization.

Cash flows are classified as cash flows from operating activities, cash flows from financing activities and cash flows from investing activities in the cash flow statement which is prepared along with Financial Statements.

Cash flows from operating activities:

Operating activities are the activities undertaken by the organization to earn profit. Sale of goods, rendering of services etc are the example of operating activities.

Examples: cash received from sale of goods, cash payment to supplier for procurement of raw materials, increase/decrease in current assets/current liabilities, payment of wages and salaries to employees etc

Cash flows from financing activities:

Financing activities are the activities undertaken by the organization that result in changes in the size and composition of the owners capital ( including preference share capital in case of a company ) and borrowing of the organization.

Examples: cash proceeds from issuing shares or other similar instruments, cash repayments of amount borrowed etc

Cash flows from investing activities:

Investing activities are the activities undertaken by the organization that relate to the acquisition and disposal of long term assets and other investments not included in cash equivalents.

Examples: cash payment to acquire fixed assets ( including intangibles ), cash receipt from disposal of fixed assets( including intangibles ), cash advances and loans made to third parties,