Cash Basis and Accrual Basis as Methods of Financial Reporting - Assignment Example

Name Course Lecturer Date Chapter 4 Discussion Question 6 (page 156) The owner of a business reviews the income statement prepared by you and asks, “Why do you report a profit of only $30 000 when cash collections of $100 000 were received and cash payments for the period totalled only $50 000 for expenses?” How would you respond to the owner’s question? (5 marks) There are two methods of financial reporting, Cash basis and Accrual basis. In the cash basis, revenues and expenses are reported as and when cash is received and paid out respectively. In accrual basis, the income statement reflects incomes as they are earned and expenses as they are incurred (Helfert). In preparing these income statements, I have used the accrual basis as it provides a more accurate depiction of the firm’s financial position at a particular point in time. This basis is best as it applies the matching principle which ensures all expenses incurred and incomes earned during a period are recorded. Exercise 4.15 Adjusting entries and effect on financial statements (page 162) (( WESTON CAR RENTAL Required: A. Prepare the necessary adjusting entries in general journal form.(8 marks) B. Determine the effects of the adjustments on the financial statements by completing the schedule presented. (4 marks) C. 1. Did profit increase or decrease? By how much?(1 mark) 2. What was the effect of the adjusting entries on total assets? Total liabilities? Total equity?(3 marks) A. Date Details Debit Credit 31 December Wages 3,100 31 December Wages payable 3,100 31 December Vehicle Depreciation 8,000 31 December Motor Vehicle 8,000 31 December Rent 840 31 December Rent Receivable 840 31 December Cash 550 31 December Prepaid Rent 550 B. WESTON CAR RENTAL Financial Statements Unadjusted balances Adjustments (use a + or – to show if the account is increasing or decreasing) Adjusted balances Income statement Rental revenue $142 000 +840 $142 840 Expenses: Depreciation expense - +8,000 8,000 Insurance expense 26 000 26 000 Wages expense 78 000 +3 100 81 100 General expenses 12 000 12 000 Profit $26 000 $15 740 Statement of changes in equity Beginning capital $50 000 $50 000 Add: Profit 26 000 -10 260 15 740 Less: Drawings (40 000) (40 000) Ending capital $36 000 $25 740 Balance sheet Cash at bank $26 000 +550 26 550 Revenue (accrued) receivable - +840 840 Other receivables 6 000 6 000 Vehicles 68 000 68 000 Less: Accum. depreciation (32 000) +8 000 (40 000) $68 000 $61 390 Wages payable - +3 100 3 100 Unearned rental revenue 4 000 +550 4 550 Loan payable 28 000 28 000 Naomi Weston, Capital 36 000 -10 260 25 740 $68 000 $61 390 C. The profit decreased from $26 000 to $16 740 which is a decrease of: 26 000 – 16 740 = $10 260 Total assets decreased from $68 000 to $61 390 which is a decrease of: 68 000 - 61 390 = $6 610 Total liabilities decreased from $68 000 to $61 390 which is a decrease of: 68 000 - 61 390 = $6 610 Total equity decreased from $36 000 to $25 740 which is a decrease of: 36 000 to 25 740 = $10 260 Decision Case Home sewing business (page 174) LANA PRIEST Required: A. Prepare an income statement for the year ended 30 June 2014 using accrual accounting. B. Prepare an income statement for the year ended 30 June 2014 using cash accounting. (A & B combined = 10 marks) C. Lana was not sure whether she could use cash accounting rather than accrual accounting for her business records. From the information provided, decide whether Lana should use accrual or cash accounting, and explain to her the reasons for your decision. (4 marks) A & B LANA PRIEST Income Statement for the year ending 30 June 2014 Accrual Basis Cash Basis $ $ Sewing Revenue 38 400 38 400 Less Expenses $ $ Sewing supplies expense Insurance Repairs to machines Sundry expenses Repairs to machines 4840 2300 2650 540 270 (10 600) 4610 2650 (7260) Profit 27 800 31 140 C. Lana Priest has just started a small sewing business. In order to decide which of the two methods to use, one must first understand their difference. In cash basis accounting, transactions are recorded in the books when the actual cash changes hands (McQuaig, Bille and Nobles). This means that expenses are recorded when cash is paid out and revenues recorded when cash or cheque is received (McQuaig, Bille and Nobles). In accrual accounting, transactions are recorded as they occur regardless of whether cash changes hands. Transactions on credit are recorded in either accounts receivable account or accounts payable account until payment is received or paid out respectively (Palmer, Palmer and Coombs). Since this is a small start up, Lana Priest should use the cash basis accounting for her book keeping. Cash basis accounting is easy to maintain and enables the business proprietor to more easily and accurately track incomes and expenditure. This in turn allows accurate tracking of cash flows. Chapter 6 Discussion Question 8 (page 258). Why do businesses that use a perpetual inventory system continue to perform a physical stock take at least once a year? (3 marks) Perpetual inventory denotes a system of recording stock after each receipt and issue so as to facilitate regular inspection and avert closing down of business for stock-taking. Perpetual inventory system comprises of bin cards which is maintained by the store keeper and a stores ledger which is maintained by the accountant. Physical stock take is taken because there may be differences between the bin card and the stores ledger. There may also be cases of discrepancies or fraud which are averted by means of a physical stock take. Problem 6.4 Journal entries – perpetual and periodic inventory systems (page 264) MUSONDA’S MARKETS Required: A. In two columns, prepare general journal entries assuming: 1. A periodic inventory system is used. 2. A perpetual inventory system is used. (12 marks) B. Do not complete Requirement B. C. Suppose that a physical count of the inventory at the end of the current period shows inventory of $13 200 to be on hand. Present the entries (if any) required under each inventory system to adjust for any discrepancy. Show how you have calculated the $ Amounts included in any journal entry you complete. (4 marks) D. Do not complete Requirement D. A. MUSONDA’S MARKETS (Periodic) Date Details Debit Credit Purchases 11 570 Accounts Payable 11 570 Accounts payable 670 Purchases returns 670 Accounts payable 10 900 Cash 10 791 Purchases discounts 109 Accounts Receivable 11 400 Cash 9 800 Sales 21 200 Sales Returns 860 Accounts Receivable 860 MUSONDA’S MARKETS (Perpetual) Date Details Debit Credit Purchases 11 570 Accounts Payable 11 570 Accounts payable 670 Inventory 670 Accounts payable 10 900 Cash 10 791 Inventory 109 Accounts Receivable 11 400 Cash 9 800 Sales 21 200 Cost of Goods Sold 10 600 Inventory 10 600 Sales Returns 860 Accounts Receivable 860 Inventory 430 Cost of Goods Sold 430 C. No entries are required to correct the discrepancies D. The perpetual inventory system is best placed to report any discrepancy because it provides accurate accounting records as they are up to date ensuring more vigilance in record keeping. This method therefore ensures early and easy detection of any discrepancies. Works Cited Helfert, Erich A. "The Nature of Financial Statements: The Income Statement." Financial Analysis - Tools and Techniques - A Guide for Managers (2001): 40. McQuaig, Douglas J., et al. College Accounting. Cengage Learning, 2010. Palmer, William J., et al. Construction Accounting & Financial Management. McGraw-Hill Professional, 1999. Read More