Learn how in accrual accounting revenue is recorded in the period it was earned and expenses are recorded in the period they were incurred—regardless of when cash flows.
- For the year end of June 30, 2016, Microsoft reported net income for the year just ended of almost 17 billion dollars. For the same period of time, the company reported cash from operations of over 33 billion dollars. - How did Microsoft do for the year? Did they make 17 billion or 33 billion? Individuals often confuse net income with cash from operations. - Well isn't net income supposed to be equal to the amount of cash generated from the successful operations of a business? - No. For a variety of reasons most of them related to the concept of accrual accounting, net income and cash flow from operations are seldom the same number.
- What is this concept called accrual accounting? - Accrual, not cruel, accrual accounting means that revenues are recognized or recorded on a company's books when they are earned without regard to when the cash is received. Expenses are recorded as they are incurred without regard for when they are paid. - What you're saying is that when a company does the work, they record the work as revenue on the income statement? When they receive payment, they record the payment separately as an inflow of cash but not as a revenue.
- Correct, revenue is recorded once when it's earned. The cash flow is recorded once when the cash is received. If those two events happen in the same accounting period, then cash flow and income will be the same. When financial statements need to be prepared and the two events are in different periods, the numbers will be different. - Well, I bet there's a lot of types of transactions that are not done at the end of a month, or the end of a quarter, or at the end of a year. - Correct again. That's why the income statement and the statement of cash flow differ because a lot of transactions are part way done at the end of the quarter.
- Does the same logic apply to expenses? - Absolutely, except the other way. In the case of expenses, costs are being incurred and cash is flowing out of the business. When the cost being incurred happened in a different period than when the costs are paid for, like when the pay period ends on December 31st and employees don't get paid until the first week in January, then the concept of accrual accounting puts the expense and the cash out flow in different accounting periods. - What is Microsoft's biggest accrual adjustment? - Well, in fiscal 206, Microsoft received over 57 billion dollars in cash from customers regarding work that they, Microsoft, will not do until future periods.
- You mean for work for like continuous software upgrades and such for which a customer pays when they initially purchase the software? - That's exactly right. Customers can expect those upgrades over time without having to pay any more in the future. - Wow, so that's 57 billion received now that they don't get to record as revenue until they actually provide the service of product, 57 billion. That had to hurt income. - It did, but don't feel too bad for Microsoft. During that same period of time, they were able to record as revenue almost 49 billion dollars for services and product upgrades provided during fiscal 2016 for which they had received the cash previously.
- Accrual accounting gets its recording revenues in the period that they were earned and expenses in the period they were incurred regardless on when the cash flows.
Skill Level Beginner
Q: Why can't I earn a Certificate of Completion for this course?
A: We publish a new tutorial or tutorials for this course on a regular basis. We are unable to offer a Certificate of Completion because it is an ever-evolving course that is not designed to be completed. Check back often for new movies.