Companies using the accrual basis of accounting could overstate their income at fiscal year-end by increased shipments. Which two accounts would be most at risk?

Question

Business

Cristopher Liu

11 December, 15:35

Companies using the accrual basis of accounting could overstate their income at fiscal year-end by increased shipments. Which two accounts would be most at risk?

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Answers (1)

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Holly Griffin · Answer 1

Sales and Account Receivable

Explanation:

Accrual Basis

The accrual basis of accounting is the principle of accounting where income is recognized when it occurs and not when cash is received. In order words, once sales is made even before the cash from the sales is received, sales is to reflect the transaction.

Once income for the fiscal year-end is overstated by increased shipments, first sales will be at risk because income means sales have occurred, therefore increased shipments mean increased sales. Sales must increase to match the the shipment.

Secondly, increase in sales automatically means increase in accounts receivable (remember, accrual basis means the account receivable is to reflect expected cash income as a result of sales). So increased sales as a result of increased shipment also affects increase in account receivable.