If revenues are recognized before they are earned without adjusting entries, what would happen to the financial statements?

• A. Revenues and net income would be overstated.
• B. Revenues would be overstated and net income overstated; adjusting entries would correct this by recognizing revenue in the period earned.
• C. Assets would be overstated.
• D. There would be no impact on financial statements.

Answer: (B)

Revenue recognition under accrual accounting means revenue is recorded when it is earned, not when cash is received or when the sale is recognized prematurely. If revenue is recognized before it’s earned, the income statement in that period would show too much revenue, which inflates net income.

The correction is to adjust the books so the revenue is recognized in the period it’s actually earned. This typically involves an adjusting entry that moves the premature revenue out of the current period and into the period earned (and, if applicable, adjusts any related unearned revenue/liability). In short, recognizing revenue too early makes revenues and net income higher than they should be, and the adjusting entry fixes this by aligning revenue with the period it was earned.