(Learning Objective 1: Explain how accrual accounting differs from cash-basis ac
ID: 2578636 • Letter: #
Question
(Learning Objective 1: Explain how accrual accounting differs from cash-basis accounting)Hough Consulting had the following selected transactions in July:
July 1 Prepaid insurance for July through September, $4,200.
2 Purchased office furniture for cash, $5,000.
3 Performed consulting services for a client on account, $3,500.
5 Paid advertising expense, $500.
10 Performed consulting services and received cash, $1,500.
20 Purchased a computer on account, $2,500.
25 Collected for July 3 service.
26 Paid account payable from July 20.
29 Paid salary expense, $1,800.
31 Adjusted for July insurance expense (see July 1).
31 Earned revenue of $1,000 that was collected in advance back in June.
31 Recorded July depreciation on fixed assets, $125.
LO USING EXCEL:
1. Show how each transaction would be handled (in terms of recognizing revenues and expenses) using the cash basis and the accrual basis.
2. Compute July income (loss) before tax under each accounting method
3. Indicate which measure of net income or net loss is preferable. Use the transactions on July 3 and July 25 to explain.
(Learning Objective 1: Explain how accrual accounting differs from cash-basis accounting)Hough Consulting had the following selected transactions in July:
Explanation / Answer
(A)Treatment of Transactions
Date
Cash
Accrual
1
Prepaid Insurance
-4200
-4200
2
Office Furniture
-5000
-5000
3
Consulting Service
3500
5
Advertisement Exp.
-500
-500
10
Consulting Service given
1500
1500
20
Computer
-2500
25
Consulting Service
3500
(Here on cash basis this service will be recorded as
income on 25th July, whereas it has been recorded as
income on 3rd July in accrual method and debit has been
created for Accounts receiveable. On receipt of Cash on
25th, said accounts receivable would be credited and cash
a/c would be debited.)
26
Computer
-2500
-
(Since cash has been paid on 26th, on cash basis this date
will be treated as computer purchase date whereas for accrual
method, 20th july will be treated as purchase date and credit has
been recorded as accounts payable. On 26th, said accounts payable
would be debited and cash would be credited.)
29
Salary
-1800
-1800
31
Expense for July
-
-1400
(Insurance paid for 3 months from July to September wil be
recorded as expense proportionately in all three months in
accrual basis. In cash basis whole amount would be recorded as
expense on the date of cash payment viz. July 1)
31
Revenue
-
1000
Revenue has been earned on this day hence treated as
revenue on this day in accrual basis. In cash basis it has
been treated as revenue on the day of receipt of cash
i.e. in June month.)
31
Depreciation
-125
-125
Date of July
Cash
Accrual
1
Prepaid Insurance
-4200
-
3
Consulting Service
-
3500
5
Advertisement Expense
-500
-500
10
Consulting service
1500
1500
25
Consulting service
3500
-
29
Salary
-1800
-1800
31
Insurance expense for July adjusted
-
-1400
31
Revenue received in advance but earned on 31st July
-
1000
31
Depreciation
-125
-125
Income / - loss
-1625
2175
(C). From the given set of transactions, it is apt that accrual method of transactions is apt for recording true and fair view of accounting. Since, it shows the real picture and relates the expense or income of the relevant period in that respective period only whereas cash basis does not show true and fair view as cash can be paid or received any time depending upon the availability of cash or credit terms available but that does not necessarily mean the expense or income is relevant to that period. Cash basis can misguide the proper analysis of income and expense for any relevant period.
(A)Treatment of Transactions
Date
Cash
Accrual
1
Prepaid Insurance
-4200
-4200
2
Office Furniture
-5000
-5000
3
Consulting Service
3500
5
Advertisement Exp.
-500
-500
10
Consulting Service given
1500
1500
20
Computer
-2500
25
Consulting Service
3500
(Here on cash basis this service will be recorded as
income on 25th July, whereas it has been recorded as
income on 3rd July in accrual method and debit has been
created for Accounts receiveable. On receipt of Cash on
25th, said accounts receivable would be credited and cash
a/c would be debited.)
26
Computer
-2500
-
(Since cash has been paid on 26th, on cash basis this date
will be treated as computer purchase date whereas for accrual
method, 20th july will be treated as purchase date and credit has
been recorded as accounts payable. On 26th, said accounts payable
would be debited and cash would be credited.)
29
Salary
-1800
-1800
31
Expense for July
-
-1400
(Insurance paid for 3 months from July to September wil be
recorded as expense proportionately in all three months in
accrual basis. In cash basis whole amount would be recorded as
expense on the date of cash payment viz. July 1)
31
Revenue
-
1000
Revenue has been earned on this day hence treated as
revenue on this day in accrual basis. In cash basis it has
been treated as revenue on the day of receipt of cash
i.e. in June month.)
31
Depreciation
-125
-125
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