Question

On January 1, 2011 CleanCo credited Revenue for a $4,000 prepayment it received from a customer for maintenance services to be provided over the next two years.

If Revenue is not adjusted as of December 31, 2011 then ___________

Answer 1

If Revenue is not adjusted as of December 31, 2011, CleanCo's financial statements will overstate its revenue and net income for the year, failing to adhere to the matching principle.

Step-by-step explanation:

If Revenue is not adjusted as of December 31, 2011, then the financial statements will not accurately reflect the financial position of CleanCo. Typically, the $4,000 received should be recorded as unearned revenue, a liability that represents services that are yet to be provided. Over time, as the maintenance services are performed, this amount should be recognized as revenue. Assuming that services are provided evenly over two years, CleanCo should have recognized $2,000 (half of the prepayment) as revenue by the end of 2011. Without this adjustment, the revenue for 2011 would be overstated, and net income would be higher than it should be. This violates the matching principle in accounting, which states that expenses should be matched with the revenues they help to generate in the same period.