Under the accrual basis of accounting, which of the following statements is true?
I. Reported net income provides a measure of operating performance.
II. Revenue is recognized when cash is received, and expenses are recognized when payment is made.
III. Cash inflows are recognized when they are received, and cash outflows are recognized when they are made.
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A. B. C. D.D
Under the accrual basis of accounting, the matching principle is followed, which states that revenues and expenses should be recognized when they are earned or incurred, regardless of when the cash is received or paid. Let's analyze each statement to determine its accuracy:
I. Reported net income provides a measure of operating performance. This statement is true. Under the accrual basis, revenues are recognized when they are earned, and expenses are recognized when they are incurred, regardless of when the cash is received or paid. As a result, reported net income reflects the operating performance of a company over a specific period, taking into account revenues and expenses related to that period.
II. Revenue is recognized when cash is received, and expenses are recognized when payment is made. This statement is false. The accrual basis of accounting recognizes revenue when it is earned, irrespective of when cash is received. Similarly, expenses are recognized when they are incurred, regardless of when payment is made. This principle ensures that financial statements provide a more accurate depiction of a company's financial performance and financial position.
III. Cash inflows are recognized when they are received, and cash outflows are recognized when they are made. This statement is false. Under the accrual basis, cash flows are not the primary focus for revenue and expense recognition. Instead, the focus is on the actual occurrence of the revenue-earning or expense-incurrence events. Cash inflows and outflows may or may not align with the recognition of revenues and expenses. For example, a company may recognize revenue in one period but receive the cash payment in a subsequent period.
Based on the analysis above, the correct answer is A. I only. Statement I accurately describes the accrual basis of accounting, while statements II and III do not.