Katie Vote owns a small business that rents computers to students at the local university for the nine-month school year. Katie’s typical rental contract requires the student to pay the year’s rent of $900 ($100 per month) in advance. When Katie prepares financial statements at the end of December, her accountant requires that Katie spread the $900 over the nine months that a computer is rented. Therefore, Katie can recognize only $400 revenue (four months) from each computer rental contract in the year the cash is collected and must defer recognition of the remaining $500 (five months) to next year. Katie argues that getting students to agree to rent the computer is the most difficult part of the activity so she ought to be able to recognize all $900 as revenue when the cash is received from a student.
Required:
Explain why generally accepted accounting principles require the use of accrual accounting rather than cash-basis accounting for transactions like the one described here.