If a company incorrectly records cash received for services to be provided in the future by debiting cash and crediting sales revenue, this results in recognizing revenue prematurely. According to accounting principles, revenue should only be recognized when earned, i.e., when the services are actually provided. Effect on Net Income for the Current Period:
- Overstatement of Revenue: Recording the cash receipt as sales revenue inflates revenue figures for the current period even though the services have not yet been delivered.
- Overstatement of Net Income: Since revenue is overstated without the corresponding expense or service delivery, net income will also be overstated for the current period.
- Balance Sheet Impact: The correct treatment would be to credit a liability account such as "Unearned Revenue" or "Deferred Revenue," reflecting the obligation to provide services in the future. By crediting sales revenue instead, liabilities are understated and equity is overstated.
In summary, this error causes net income to be overstated in the current period because revenue is recognized before it is earned
. The proper accounting treatment is to defer the revenue until the services are performed.
