Cash and Accrual Basis

Chapter 9

Methods of Accounting

Cash Basis

and

Accrual Basis

Accounting Methods

Cash Basis

Records revenue

when received.

Records expenses

when paid.

Accrual Basis

Records revenue

when earned.

Records expenses

when incurred.

Cash

Basi

sThis approach does

not recognize accounts receivables, accounts payable, accrued income, deferred income, accrued expense, and prepaid expense.

Acc

rual B

asi

s

The essence of this approach is the recognition of accounts receivables, accounts payable, accrued income, deferred income, accrued expenses and prepaid expenses.

Cash Basis vs. Accrual Basis

Item Cash Basis Accrual Basis

Sales Cash Sales plus collection of trade receivables

Cash sales plus sales on account

Purchases Cash purchases plus payments to trade creditors

Cash purchases plus purchases on account

Income other than sales

Items receive are considered as income regardless of when earned

Items earned are considered as income regardless of when received.

Items Cash Basis Accrual Basis

Expenses Items paid are treated as expenses regardless when incurred

Items incurred are treated as expenses regardless when paid

Depreciation Depreciation is provided normally

Depreciation is provided normally

Bad Debts No bad debts are recorded because receivables are not recognized

Doubtful accounts are treated as bad debts

Accounting problem

Conversion from CASH basis to ACCRUAL basis of accounting

Computation of Sales

Cash sales xxSales on account:

Trade accounts and notes receivables, end xxCollection of trade accounts and notes receivable xxSales returns, discounts, and allowances xxAccounts and notes receivable written off xxTrade notes receivable discounted

(Note Receivable directly credited) xxTotal xxLess: Trade accounts and notes receivable, beg xx xx

Total sales- accrual basis xx

Computation of purchases

Cash purchases xxPurchases on account:

Trade accounts and notes payable, end xxPayment of trade accounts and notes payable xxPurchases returns, discounts, and allowances xxTotal xxLess: Trade accounts and notes payable, beg xx xx

Total purchases- accrual basis xx

Income other than sales

Income Received – cash basis xxAdd: Deferred income – beginning xx

Accrued income- endingxxTotal xxLess: Deferred income– ending xx

Accrued income– beginning xx xxIncome for the current year – accrual basis xx

Expenses in general

Expenses paid– cash basis xxAdd: Prepaid expenses– beginning xx

Accrued expenses- ending xxTotal xxLess: Prepaid Expenses – ending xx

Accrued expenses – beginning xxxxExpenses – accrual basisxx

Problems

Cash and Accrual Method Illustrations

Problem 9-3 ABC Corporation

Required: Prepare a comparative income statement using the cash basis and accrual basis of accounting.

ABC Corporat ionIncome Statement

Year ended December 31, 2011

Cash Basis Accrual Basis

Sales 3,200,000 3,350,000Cost of Sa les:

Merchandise Inventory, Jan. 1 500,000 500,000

Purchases 2,050,000 2,100,000Tota l 2 ,550,000 2,600,000Merchandise Inventory,Dec.31 (600,000) (600,000)Cost of Sa le 1,950,000 2,000,000

Gross Income 1,250,000 1,350,000Interest Income 40,000 30,000Tota l Income 1,290,000 1,380,000Less: Expenses

Expenses pa id in cash 750,000 750,000

Accrued Expenses - 20,000Prepaid Expenses - (30,000)Depreciat ion 50,000 50,000Tota l Expenses 800,000

790,000Net Income 490,000 590,000

Computations:

Cash Basis Accrual Basis>>Sales:

Sales on Cash 2,500,000 2,500,000Sales on account - 850,000Col lect ions from costumers 700,000* -Total Sales 3,200,000 3,350,000

*Col lect ions from costumers:Accounts Receivable, Jan. 1 250,000Sales on account 850,000Accounts Receivable, Dec. 31 (400,000)

Total 700,000

Cash Basis Accrual Basis>> Purchases:

Cash Purchases 1,700,000 1,700,000Credit Purchases - 400,000Payments to creditors 350,000** -Total Purchases 2,050,000 2,100,000

**Payments to Creditors:Accounts Payable, Jan. 1 150,000Credit Purchases 400,000Accounts Payable, Dec. 31 (200,000)Total 350,000

Cash Basis Accrual Basis>> Interest Income:

Interest received 40,000 40,000Accrued interest

receivable, beg - (10,000)Total 40,000 30,000

>> Depreciation:(800,000/10) 80,000 80,000(200,000/10* 6/12) 10,000 10,000

Problem 9-4 Aris MarvalRequired:

1. Income Statement

2. Statement of financial position

3. Adjusting entries to convert the records to accrual basis of accounting

Journal Entries2011Dec 31 Retained Earning 125,000

Accumulated Depreciation 125,000#

Depreciation 250,000Accumulated Depreciation 250,000

#

Interest Expense 90,000Accrued Interest Expense 90,000

#

Professional Fees 500,000Retained Earnings 500,000

#

Journal Entr ies:

2011Dec.31 Accounts Receivable 750,000

Profess ional Fees 750,000#

Rent Expense 100,000Accrued Rent Payable 100,000

#

Offi ce Suppl ies 300,000Reta ined Earnings 300,000

#

Offi ce Suppl ies Expense 50,000Offi ce Suppl ies 50,000

#

ARIS MARVALIncome Statement

Year ended December 2011

Professional Fees 5,250,000Expenses:

Rent Expense 1,300,000Suppl ies Expense 850,000Interest Expense 90,000Depreciat ion 250,000Other expenses 750,000 3,240,000

Net Income 2,010,000

Computat ions:

>>Profess ional Fees:Profess ional fees pa id in cash

5,000,000Profess ional fees on account:

Accounts Receivable,2011 750,000Accounts Receivable,2012 (500,000) 250,000

Tota l Profess ional fees-accrual 5,250,000

>>Rent Expense:Rent Expense paid in cash 1,200,000Accrued Rent Expense

100,000Tota l Rent Expense-accrual 1,300,000

Computat ions:

>>Offi ce Suppl ies expense:Unused offi ce suppl ies,2011 250,000Acquired Offi ce suppl ies 800,000Unused Offi ce suppl ies,2010 (300,000)

Tota l Offi ce suppl ies expense-accrual 850,000

>>Interest Expense:(1,000,000 x 12% x 9/12) 90,000

>>Depreciat ion:(2 ,500,000/10)

250,000

ARIS MARVALSta tement o f Financ ia l Pos i t i on

As o f December 31 , 2011

ASSET

Cash 1 ,500 ,000Accounts Rece ivab le 750 ,000Offi ce Supp l i es 250 ,000Furn i tu re and Equ ipment 2 ,500 ,000Accumula ted Deprec ia t i on ( 375 ,000) 2 ,125 ,000 4 ,625 ,000

L IAB IL IT IES

Notes Payab le 1 ,000 ,000Accrued In te res t Payab le 90 ,000Accrued Rent Expense 100 ,000 1 ,190 ,000

CAP ITAL

Ba lance , J an . 1 1 ,600 ,000Add: Net I ncome 2,010 ,000

Reta ined Earn ings 675 ,000Tota l 4 ,825 ,000Less : Wi thdrawa l ( 850 ,000) 3 ,435 ,000

4 ,625 ,000

Computations:

>>Accumulated Depreciat ion:Depreciat ion, July-Dec.2010(2,500,000/10 x 6/12) 125,000Depreciat ion, Jan.-Dec. 2011(2,500,000/10) 250,000

Total 375,000

>>Retained Earnings:Professional fees 500,000Depreciat ion (125,000)Offi ce suppl ies 300,000

Total 675,000

Problem 9-4 Zamboanga Required:

1. Adjusting entries to convert the records to accrual basis of accounting

2. Income Statement

3. Statement of financial position

Adjust ing Entr ies:

1. Sa les 200,000Reta ined Earnings 200,000

#

Accounts Receivable 250,000Sales 250,000

#

2. Reta ined Earnings 40,000Sales 40,000

#

3. Reta ined Earnings 350,000Purchases 350,000

#

Purchases 280,000Accounts Payable 280,000

#

4. Retained Earnings 70,00Expenses 70,000

#

Expenses 100,000Accrued Expenses 100,000

#

5. Inventory- Dec 31,2010 150,000Retained Earnings 150,000

#

Inventory – Dec 31,2011 210,000Profit or Loss 210,000

#

6. Advances to Supplier 100,000Purchases 100,000

#

7. Retained Earnings 10,000 Depreciation –Equipment 20,000

Accumulated Depreciation 30,000#

8. Retained Earnings 300,000 Depreciation – Building 300,000

Accumulated Depreciation 600,000#

9. Doubtful Accounts 25,000Allowance for doubtful accounts 25,000

#

10. Interest expense 36,000Accrued Interest Payable 36,000

#

Computation :Depreciation

Depreciation for 2010Equipment acc. July 1 200,000/5x 6/12 10,000Depreciation for 2011

200,000/5 20,000Total 30,000

Doubtful Accounts 250,000 x 10% 25,000

Accrued Interest expense900,000x 12%x4/12 36,000

ZAMBOANGA COMPANYSta tement o f Financ ia l Pos i t i on

December 31 , 2011

ASSETSCurrent Asse ts :Cash 1 ,500 ,000Accounts Rece ivab le 250 ,000Less : A l l owance fo r Doubt fu l Accounts 25 ,000 225 ,000Invento ry 210 ,000 2 ,035 ,000Non- current Asse ts :

Equ ipment 200 ,000Less : Accumula ted Deprec ia t i on (30 ,000) 170 ,000

Bu i ld ing 1 ,500 ,000Less : Accumula ted Deprec ia t i on (600 ,000) 900 ,000

Land 800 ,000 1 ,870 ,000TOTAL ASSETS 3 ,905 ,000

LIABILITIES AND SHAREHOLDERS EQUITY

LIABILITIESCurrent l iabi l i t ies:Accounts Payable 280,000Accrued Expenses 100,000 380,000

Non-current l iabi l i t ies;Mortgage payable 900,000Accrued Interest payable 36,000 936,000

SHAREHOLDERS’ EQUITYShare capital 2,000,000

Retained Earnings, end 589,000 2589,000

T O TA L L I A B I L I T I E S a n d S H A R E H O L D E R S ’ E Q U I T Y 3,905,000

Note 1 Trade and other Receivables

Accounts Receivable 250,000Allowance for doubtful accounts ( 25,000)Net realizable value 225,000Advances to suppliers 100,000

total 325,000

Note 2 Equipment 200,000Accumulated Depreciation ( 30,000)Carrying Amount 170,000

Note 3 Building 1,500,000Accumulated Depreciation (600,000)Carrying Amount 900,000

Zamboanga CompanyIncome Statement

Year ended December 2011

Sales 4,090,000Less: Cost of Sales

Inventory ,beg 150,000Add: Purchases 1,830,000Goods Avai lable for sale 1,980,000Less: Inventory, end 210,000

1,770,000Gross Income2,320,000Expenses:

Expenses 1,530,000Doubtful accounts 25,000Depreciat ion 320,000 Interest Expense 36,000 1,911,000

Net Income 409,000

Computation of sales

Sales per book 4,000,000Add: Accounts Receivable, end 250,000Total 4,250,000Les: Accounts Receivable, beg 200,000 Credit adjustment to sales 40,000Sales 4,090,000

Computation of Purchases

Purchases per book 2,000,000Add: Accounts Payable , end 280,000Total 2,280,000Less: Accounts payable, beg 350,000 Advances to supplier 100,000Purchases 1,830,000

Computation of Expenses

Expenses per book 1,500,000Add: Accrued Expenses, end 100,000Total 1,600,000Less: Accrued Expenses, beg 70,000Expenses 1,530,000

Computation of Retained Earnings

Retained Earnings per book 600,000Add: Unrecorded Accounts Receivable, 2010 200,000 Unrecorded inventory 150,000 Profit or loss Adjustment 210,000Total 1,160,000Less: Error in recording sales 40,000 Unrecorded Accounts payable 350,000 Unrecorded Accrued Expense 70,000 Unrecorded Depreciation- equipment 10,000 Unrecorded Depreciation – building 300,000Retained Earnings 390,000