Practice question · Multiple choice
A firm can be profitable and run out of cash in the same quarter. Which accounting convention makes that possible?
Hints
- Ask when a sale on 90-day credit becomes revenue, and when it becomes cash.
- A growing firm sells more and more on credit. What happens to each of the two figures?
Show the answer
C. Accrual accounting: revenue is recognised when earned
Why
Profit measures earning and cash measures collecting, and accrual accounting deliberately separates them, which is why fast growth is a common cause of insolvency. Depreciation moves the two apart in the opposite direction, adding to cash relative to profit, so option 2 has the sign backwards.
Practise Recording Transactions
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