CSLB Law & Business ExamBusiness FinancesMedium
A contractor is managing project cash flow and receives a partial payment for work completed. How should this payment be recorded in the accounting system if the contractor uses the accrual method?
- AAs a credit to Unearned Revenue.
- BAs an increase in Revenue.
- CAs a reduction in Accounts Receivable.
- DAs an increase in Cash and a decrease in Notes Payable.
Show answer & explanationAnswer & explanation
Correct answer: C. As a reduction in Accounts Receivable.
Under the accrual method, revenue is recognized when earned, typically when work is completed and an invoice is issued, creating an Accounts Receivable. When a payment is received for that work, it reduces the outstanding Accounts Receivable balance, as the revenue was already recorded.
Why the other options are wrong
- A. Incorrect. Unearned Revenue (or Deferred Revenue) is for payments received *before* work is completed. This scenario describes a payment for work already completed.
- B. Incorrect. Revenue is recognized when earned (work completed), not when cash is received under the accrual method.
- D. Incorrect. While cash increases, Notes Payable is for loans, not customer payments for services.
Accrual Accounting - Cash Receipt for Work Done
Under accrual accounting, when cash is received for services already rendered and invoiced, the transaction reduces the Accounts Receivable balance, as revenue was recognized when earned.
- Revenue is recognized when earned, not when cash is received.
- Accounts Receivable is created when revenue is earned but cash not yet received.
- Cash receipt for prior work reduces Accounts Receivable.
Memory trick: Accrual: When you earn it, you record it; when you owe it, you record it.