Cash Basis Accounting - Assignment Example

Module Discussions

Question 2

Cash basis accounting is a reporting practice where revenues are recorded when cash is received as well as expenses being recorded when the expenses are paid. It entails recording payment of credit cards, bank debit cards and payment of checks. It requires a single entry to record each transaction. Further, only the cash inflows and cash outflows are recorded. On the other hand, accrual basis accounting entails recording exercise where revenues are recorded when they are earned and recording expenses when they are owed. It involves recording debits and credits. Here, both the seller and buyer record revenue and expenses. The entries show the revenue earned by the buyer and cash owed by the buyer.

Accrual basis accounting is acceptable in most businesses compared to cash basis accounting in that the accrual basis achieves the Generally Acceptable Accounting Principles (GAAP) in businesses, which integrates the matching concept. The recorded revenue should match with the recorded expenses within the accounting period. Both the seller and buyer record revenue and expenses based on their entries these ensures the matching principle. Therefore, actual margins and profits are made ensuring reliable financial records.

Further, accrual based records are more acceptable in most businesses because they meets accurate record keeping, the double entry principle requirements in accounting. Accurate records helps the organization to keep track about the asset base, liabilities, and equities of the business, thus, helping predict the future cash inflows and cash outflows. Hence, accrual based accounting provides efficient accounting information, which may be used to control risks that are likely to strike the business. Managers use the information in making expansion efforts, thus ensuring sustained business growth.

Question 3

Adjusting entries are an integral part of the accounting cycle as it ensures the journal entries are up to date at the end of the specific accounting period. Adjusting entries is integral as it records revenue already earned but not recorded and records expenses incurred but not recorded. To correct prepayment on expenses made, adjusting entries is integral. Moreover, it is essential as it does not affect the cash transaction in the business.

The adjustment entries include the use of estimates as a nominal part of accrual accounting process as it unreasonably predicts the cost that is likely to be incurred. Thus, it contributes to production of insufficient cash flows as recorded.

With the core values of responsible stewardship and integrity in mind management may misuse adjusting entries to affect the amount of net income or loss. Needles, Powers and Crosson (2013) illustrates that when estimation is done unrealistically the financial reports become misleading, thus, contributing to fraudulent accounting report. When revenue is overstated and expenses understated the net income affects profitability. Therefore, managers are bound to make bad decisions for the business basing on inaccurate information.

Several procedures or processes that would help to stop adjusting entries to affect net income are available. Creating procedures that ensure accounting rules are followed helps to stop adjusting entries to affect net income. The double entry rule ensures that the debit entries equal the credit entries for the ledger and journal entries. Further, setting programs that help detect recording errors and journalization helps reduce errors since it proves equalization of credit and debit balances through a trial balance (Nikolai, Bazley, and Jones 2009). Therefore, creating processes and procedures help eradicate errors thus helps maintain adequate net income for businesses.

Question 4

Federal discount rates are the discount rates charged to depository institutions and commercial banks, on loans, that they receive from regional federal lending banks. The Federal Reserve banks offer different types of discount window programs. Firstly, primary credit is usually repaid within a short period of time and the discount rate is relatively low. Additionally, secondary credit offers average discount rates on loans and the credit repayment period is less than one year. Seasonal credit discount rates depend on selected market rate.

Prime interest rates are rates used by banks to lend to their credit worthy customers and other corporations. The prime interest rates are used to determine the rates to be used for other small business loans, equity loans and personal loans.

The federal and prime rates are relatively lower compared to the historic average rates in the past decades. The rates are made low to ensure consumers can afford to get loans. Attainment of loans at lower rates encourages consumers to invest thus encouraging growth and profitability in businesses.

If I was in charge of monetary policy in the U.S., I would be inclined to lower the Federal Discount Rate from its current amount. The reduction in the discount rates increases the availability of loans thus the commercial banks borrow money at a cheaper rate. The increase in money supply caused by the availability of cheaper loans promotes a relative increase in investment activity.

The Saint Leo core values of responsible stewardship and integrity could influence the decision to lower interest rates. Considering that an increase in interest rates is likely to affect the societies’ ability to raise funds to start business and purchase personal items. Therefore, empowering people by providing cheaper interest rate could contribute highly to the growth of the economy.

Question 5

The valuation of accounts receivables is faced with different challenges. The basic problems that occur in the valuation of accounts receivables include formulating an accurate assessment. Approximating an exact amount of collectable account becomes a challenge. When managers increase the amount of accounts receivables the revenue and assets becomes overstated. Further, the use of estimation to record accounts receivable might be done unrealistically, these causes financial reports to become misleading thus contributes to fraudulent accounting report. Therefore, the accounts receivables become uncollectable and unreliable.

Additionally, determining the uncertainty of future collection of receivable is a problem that occurs in valuation of accounts receivables. The two methods used to account for uncollectable receivable are the allowance method and the written off methods of evaluation. The allowance method is more accurate as it focuses on the General Acceptable Accounting Principles (GAAP) hence, it provides reliable estimates. On the other hand, using the written off method to predict the future collection of receivable provides unreliable estimates thus, it provides an inaccurate uncollectable accounts on sales and receivables for business. Therefore, planning for future collection of accounts becomes difficult and unpredictable.

Moreover, estimation is a problem in the valuation of accounts receivables. To determine accurate and efficient accounts receivables, estimation allows for doubtful accounts. When estimation is done unrealistically the financial reports become misleading therefore contributing towards fraudulence in accounting report. When revenue is overstated and expenses understated the net income affects profitability. Therefore, managers are bound to make improper choices for the business if they are based on erroneous information. Also, the basic problems that face the valuation of accounts receivables are related to estimation and future repayments.

Question 6

Inventory valuation is the cost tagged to an inventory at the end of the accounting period. It forms an important part in the determination of the cost o goods sold and can be used in pegging the value when using the inventory as collateral. The resultant value is treated as a current asset on the balance sheet. The value reflects the cost incurred by the firm to acquire it, convert it into the condition that makes it ready for sale, and transportation cost to the place of sale. Generally, the cost incorporated in the valuation comprise direct labor, direct materials, freight, handling, import duties, and production overhead

Certain circumstance might call for inventory valuation at sales prices (net realizable value or market price). First, is the law requirements such as the international financial reporting standards which might require the value to be its market value regardless of the costs incurred to produce it. Also, the lower of cost or market (LCM) rule might require the value to be set as the market value, especially if it is lower than the recorded cost of the inventory. The LCM rule enables objective and verifiable reporting. The rule also helps implement the matching concept and the conservatism principle. Lower of cost or market(LCM) is an accounting rule for valuing inventory and, under certain conditions, securities holdings. Under the lower of cost or market rule, the inventory or securities value that owners report at the end of an accounting period is the lower of either (a) historical cost or (b) value in the market. The rule is meant to protect the consumers as well as ensuring the meeting of the GAAPs.

Question 7

Usability of assets play a role in determining if they qualify for interest capitalization. Assets that do not qualify for interest capitalization are assets that are not undergoing the process to make them ready for use and they include inventory. These are assets that are not ready to be used in bringing income for the firm or assets that are not undergoing any activities to prepare them ready for use. Inventories are stocks of items at hand for businesses. Inventory does not qualify to attain interest capitalization since they do not make any incomes for the particular business. Further, inventories produced in repetitive bases and those that are produced in bulk do not qualify for interest capitalization.

Assets that are not ready for use also do not qualify for interest capitalization. These occur because the assets do not generate any earnings. Assets that are ready for their intended use do not qualify for interest capitalization. An example is farrow or uncultivated land; it does not generate any income earnings for the owner. Properties for instance motor vehicles and machinery that are non-operational and those that need repair also do not qualify for interest capitalization.

Fixed assets; land, permanent buildings’, personal properties do not qualify for interest capitalism. Only the properties that are on lease, commercial purposes qualify for interest capitalization as they create extra income earning for individuals and businesses. Another example of such assets include obsolete machines due to advancement in technology or excess capacity. Therefore, assets that do not qualify for interest capitalization are those that cannot create value for the firm in their current status. They have to be improved or undergo several process before they qualify for interest capitalization.

Question 8

Intangible assets possess two main characteristics that differentiate them from other assets. First, they are not physical as opposed to tangible ones which has a physical representation such as a factory, machines, or office building. They cannot be seen or touched, thus, they exist in form of legal authority. Intangible assets are valued by placing a value on the asset which could be higher than that of physical assets. Further, tangible assets are intellectual property. An example of an intangible asset is goodwill for a business. Goodwill is a value of a business derived from attributes such as customer loyalty to the brand. The attributes are not physical but they play a critical role towards business growth. Goodwill is valued as an intangible asset for the business. Another example is a patent right given to a business. A patent is an intangible asset that grants specific ownership of property.

The second attribute is that an intangible asset must be identifiable. The attribute implies that the intangible asset must be separable from all other assets. Thus, the asset can be sold separately or be transferable in its own rights. An example is the existence of value of goodwill, separated from the evaluation of the value of the business. Furthermore, the intangible asset must have a legal right or contractual agreement that enables for the use of a specific good or attainment of certain services. An example is the existence of a patent certificate granted by legal authorities, is an agreement that binds the right to use a specific property. Also, the identifiability attribute implies that the gains or expectations from the asset must continue into the future.

Reference

Needles, B. E., Powers, M., & Crosson, S. V. (2013). Principles of accounting. Cengage Learning.