Soln2-07 - Problem Solutions Chapter 2 35 PROBLEM SOLUTIONS...

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Unformatted text preview: Problem Solutions Chapter 2 35 PROBLEM SOLUTIONS 2-1 Accrual and Cash-based Accounting 1. Impact on Revenues and Expenses Date Cash-based Accounting Accrual Accounting June 2 Expense $ 900 (= Reduce liability) -0- June 6 Revenue 6,800 Revenue $ 6,800 June 10 -0- Revenue 7,000 June 15 Expense 1,600 Expense 1,600 June 18 Revenue 800 (= Liability) -0- June 22 Expense 10,000 (= Asset) -0- June 29 Expense 7,500 (= Asset) -0- June 30 -0- Expense 3,000 2. Net income under cash-based accounting and accrual accounting: Cash Basis Revenues = $ 7,600 Accrual Basis Revenues = $ 13,800 Cash Basis Expenses = 20,000 Accrual Basis Expense = 4,600 Net Income (Loss) $ (12,400) Net Income (Loss) $ 9,200 Notice that cash-based accounting does a poor job of matching the costs and the benefits of operating the business for any given period of time and does not provide a good measure of the work performed. Under cash-based accounting, the $7,500 prepayment of rent appears as an expense when the cash is paid rather than as an asset. This doesnt take account of the fact that the prepayment has future value. The same occurs with the acquisition of the equipment, which has future value, but is shown as an expense of the current period. These result in poor matching of expenses with the revenues that are generated by the expenses. Also, providing services on account ($7,000) does not appear as work performed in June under cash-based accounting, and the $900 advance is shown as work performed in June under the cash basis, but in fact it is a liability to perform services in the future. Accrual accounting does a much better job of measuring the profits from a business compared to cash-based accounting. INTRODUCTION TO FINANCIAL REPORTING AND ANALYSIS 4 TH EDITION 36 2-2 Accrual and Cash-based Accounting 1. Impact on Revenues and Expenses Date Cash-based Accounting Accrual Accounting July 2 Expense $ 1,500 (= Reduce liability) -0- July 6 Revenue 5,500 Revenue $ 5,500 July 10 -0- Revenue 8,000 July 15 Expense 2,800 Expense 2,800 July 18 Revenue 1,500 (= Liability) -0- July 22 -0- (= Asset) -0- July 29 Expense 9,000 Expense (Asset = 6,000) 3,000 July 30 -0- Expense 1,300 July 31 -0- Expense 2,800 2. Net income under cash-based accounting and accrual accounting: Cash Basis Revenues = $ 7,000 Accrual Basis Revenues = $ 13,500 Cash Basis Expenses = 13,300 Accrual Basis Expense = 9,900 Net Income (Loss) $ (6,300) Net Income $ 3,600 Notice that cash-based accounting does a poor job of matching the costs and the benefits of operating the business for any given period of time and does not provide a good measure of the work performed. Under cash-based accounting, the prepayment of future amounts (such as the $6,000 for August and Septembers rent) appears as an expense when the cash is paid rather than when the future benefits are used. This results in poor matching of expenses with the revenues that are generated by the expenses. Also, the services performed on account ($8,000) are generated by the expenses....
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This note was uploaded on 04/04/2008 for the course ACC 271 taught by Professor Klem during the Winter '08 term at University of Michigan.

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Soln2-07 - Problem Solutions Chapter 2 35 PROBLEM SOLUTIONS...

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