You have recently been hired by Davis & Company, a small public accounting firm.

Question

You have recently been hired by Davis & Company, a small public accounting firm. One of the firm's partners, Alice Davis, has asked you to deal with a disgruntled client, Mr. Sean Pitt, owner of the city's largest hardware store. Mr. Pitt is applying to a local bank for a substantial loan to remodel his store. The bank requires accrual based financial statements but Mr. Pitt has always kept the company's records on a cash basis. He does not see the purpose of accrual based statements. His most recent outburst went something like this: "After all, I collect cash from customers, pay my bills in cash, and I am going to pay the bank loan with cash. And, I already show my building and equipment as assets and depreciate them. I just don't understand the problem."

Draft a memo to the client to explain the importance of accrual based financial statements, make sure you: explain the difference between a cash basis and an accrual basis measure of performance, describe why, in most cases, accrual basis net income provide a better measure of performance than net operating cash flow, and explain the purpose of adjusting entries as they relate to the difference between cash and accrual accounting.

Explanation / Answer

To,

Mr. Sean Pit

From:Myself

Date: 14-04-2016

I understand that right now the situation you are in there is no need of accrual accounting to follow, but once you expnad ur store then u will understand the implication of it . In accrual basis the main advantage is u can account revenue which u did not receive cash and also accrue expense for which it is not paid. By this u can increase ur business by giving credit to customers but it will shoew higher revenue and higher profit by which the valuation of ur company will increase. Because of this it is easy to estimate future cash flows by which you can secure loan easily form any bank.

The purpose of adjusting entries which passed end of evry month will take care all the work we did for that month, example are wages payable in Feb 1st week for Jan work will be accounted in Jan month itself as it is work done for that month and samw way for revenues as well. This gives correct picture of all activities.

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