A company records items on the cash basis throughout the year and converts to an accrual basis for year end reporting. Its cash basis net income for the year is $70,000. The company has gathered the following comparative balance sheet information:
Beginning of year End of year
Accounts payable $3,000 $1,000
Unearned revenue 300 500
Wages payable 300 400
Prepaid rent 1,200 1,500
Accounts receivable 1,400 600
What amount should the company report as its accrual based net income for the current year?
A. $68,800
B. $70,200
C. $71,200
D. $73,200
C. $71,200
Cash to accrual is opposite of what you would do on a CF statement.
A/P decreased by $2,000. The cash was paid to reduce a prior year accrued expense (ie, liability). Cash basis reports the decrease as a current year expense. Therefore, this amount is added back to cash basis NI to prevent counting the expense twice.
Unearned revenue increased by $200. This indicates that amounts received were greater than amounts earned. Cash basis reports the increase as revenue. Therefore, this amount is deducted from cash basis NI.
Wages payable increased by $100. This indicates that payments made were lower than expenses incurred. Cash basis income was higher because the expenses were excluded. Therefore, this amount is deducted from cash basis NI.
Prepaid rent increased by $300. This indicates that more cash was paid than the expense incurred. Cash basis reports the increase as an expense. Therefore, this amount is added back to cash basis NI.
A/R decreased by $800. This indicates that amounts received were greater than amounts earned. Cash basis reports the decrease as revenue. Therefore, this amount is deducted from cash basis NI.
Young & Jamison’s modified cash basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual basis operating expenses, what would be the amount of operating expenses?
A. $125,000
B. $135,000
C. $165,000
D. $175,000
C. $165,000
It is helpful to create a JE for these problems.
When converting from cash payments to accrual-basis expenses, the cash paid is adjusted for the net increase or decrease in the related liability (ie, payable) and/or asset (ie, prepaid) accounts. Adjustments to cash payments are as follows.
A net increase in a prepaid (ie, debit) is deducted from cash payments to exclude the items paid for in the current period but not yet expensed (ie, incurred) under accrual accounting.
A net increase in a payable (ie, credit) is added to cash payments to include expenses that will be recorded under accrual accounting (ie, when incurred) but will be paid next period.
In this scenario, Young & Jamison must adjust the $150,000 operating cash payments for the net increases in the prepaid and payable. Setting up the journal entry shows the accrual basis expense is $165,000.
Operating expense (plug) 165,000
Prepaid accounts (↑) ($10,000 − $15,000) 5,000
Payable accounts (↑) ($5,000 − $25,000)
20,000
Cash (amount paid)
150,000
Zeta Co. reported credit sales revenue of $4,600,000 in its income statement for the year ended December 31, Year 2. Additional information is as follows:
12/31/Year 1 12/31/Year 2
Accounts receivable $1,000,000 $1,300,000
Allowance for credit losses (60,000) (110,000)
Zeta wrote off uncollectible accounts totaling $20,000 during Year 2. Under the cash basis of accounting, Zeta would have reported Year 2 sales of
A. $4,280,000
B. $4,300,000
C. $4,350,000
D. $4,900,000
A. $4,280,000
You do subtract the uncollectible accounts even though it is cash basis.
Dannon Co. mistakenly reported its expenses of $35,200 on the cash basis. Corporate records revealed the following information:
Beginning prepaid expense $1,300
Beginning accrued expense 1,650
Ending prepaid expense 1,800
Ending accrued expense 1,200
What amount of expense should the Dannon report on its books under the accrual basis?
A. $34,250
B. $35,150
C. $35,300
D. $36,150
A. $34,250
Plug 34,250
Prepaid 500
Payable 450
Cash 35200
In its Year 3 financial statements, Cris Co. reported interest expense of $85,000 in its income statement and cash paid for interest of $68,000 in its cash flow statement. There was no prepaid interest or interest capitalization either at the beginning or end of Year 3. Accrued interest at December 31, Year 2, was $15,000. What amount should Cris report as accrued interest payable in its December 31, Year 3, balance sheet?
A. $2,000
B. $15,000
C. $17,000
D. $32,000
D. $32,000
In this scenario, interest expense and cash payments are given but the payable is unknown. Because there is no prepaid or capitalized interest, any difference between the cash payments and interest expense must be due to the change in interest payable. The journal entry shows that interest payable increased by $17,000.
Interest expense (given) 85,000
Interest payable (plug the
increase) 17,000
Cash (amount paid) 68,000
Because the beginning interest payable balance was $15,000 and the payable increased by $17,000, the ending balance should be $32,000 ($15,000 + $17,000).
Sanni Co. had $150,000 in cash basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year end balances. Compared to the accrual basis method of accounting, Sanni’s cash basis pretax income is
A. Higher by $4,000.
B. Lower by $4,000.
C. Higher by $36,000.
D. Lower by $36,000.
C. Higher by $36,000.
In this scenario, Sanni Co. had $150,000 in cash basis pretax income. To compare this with accrual basis, Sanni adjusts its cash basis pretax income for changes in A/R and A/P:
A/R decreased by $20,000. This indicates that Sanni received more payments from customers than income earned. Cash basis reports this as revenue; accrual basis reports it when earned. Cash basis pretax income is higher by $20,000
A/P increased by $16,000. This indicates that Sanni had expenses in this period that were paid for in the next period. Cash basis excludes this from current year expenses; accrual basis includes expenses incurred during the period. Cash basis pretax income is higher by $16,000
Sanni’s cash basis pretax income is $36,000 higher than accrual basis NI ($20,000 + $16,000).
Savor Co. had $100,000 in cash basis pretax income for Year 9. At December 31, Year 9, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, Year 8, balances. Compared to the accrual basis method of accounting, Savor’s cash pretax income is
A. Higher by $4,000.
B. Lower by $4,000.
C. Higher by $16,000.
D. Lower by $16,000.
D. Lower by $16,000.
In this scenario, Savor Co.’s $100,000 cash basis pretax net income is increased by both the $10,000 increase in accounts receivable and the $6,000 decrease in accounts payable. Savor’s accrual-based pretax net income is $116,000 ($100,000 + $10,000 + $6,000). Cash-based net income is $16,000 less ($116,000 − $100,000) than accrual basis net income.
A consulting company keeps its accounting records on a cash basis. During the current year, the company collected $200,000 in fees from clients. At December 31 of the previous year, it had accounts receivable of $40,000. At December 31 of the current year, the company had accounts receivable of $60,000, and unearned fees of $5,000. On an accrual basis, what was the service revenue for the current year?
A. $175,000
B. $180,000
C. $215,000
D. $225,000
C. $215,000
Cash 200,000
AR 20,000
Unearned fees 5,000
Plug 215,000
A company’s cash basis net income for the year ended December 31 was $75,000. The following information is from the company’s accounting records:
January 1 December 31
Accounts receivable $15,000 $20,000
Prepaid expenses 7,000 4,000
Accrued liabilities 2,500 2,000
What is the accrual basis net income?
A. $72,500
B. $75,000
C. $77,500
D. $83,500
C. $77,500
When converting net income (NI) from cash basis to accrual basis, cash basis NI is adjusted for changes in receivables, prepaid expenses, and payables.
An increase in a receivable indicates that revenue has been earned, but no cash was received. Therefore, an increase is added to cash basis NI to arrive at accrual basis NI.
A decrease in a prepaid expense indicates that a current expense was incurred although the cash was paid in a previous period. Because an expense reduces NI, the decrease is deducted from cash basis NI to arrive at accrual basis NI.
A decrease in a payable indicates that cash was paid to reduce a liability that represents a prior year accrued expense. Cash basis reports the cash paid as a current year expense. Accordingly, the decrease is added back to cash basis NI to prevent counting the expense twice.
Cash basis NI $75,000
Increase in receivables 5,000
Decrease in prepaids (3,000)
Decrease in payables 500
Accrual basis NI $77,500
In this scenario, the company’s accrual basis NI is $77,500.
Compared to its Year 1 cash basis net income, Potoma Co.’s Year 2 accrual basis net income increased when it
A. Declared a cash dividend in Year 1 that it paid in Year 2.
B. Wrote off more accounts receivable balances than it reported as credit loss expense in Year 2.
C. Had lower accrued expenses on December 31, Year 2, than on January 1, Year 2.
D. Sold used equipment for cash at a gain in Year 2.
C. Had lower accrued expenses on December 31, Year 2, than on January 1, Year 2.
When comparing Year 2’s accrual basis net income (NI) with Year 1’s cash basis NI, payables resulting from Year 1 expenses were not recorded under cash basis. Accordingly, in Year 1, accrual basis NI was lower than cash basis NI. A decrease in accrued expenses in Year 2 indicates that cash was paid to reduce the liability representing Year 1’s accrued expense. Therefore, the amount of liability representing Year’s 1 expense results in no expense recorded in Year 2 under accrual basis, producing a higher Year 2 NI.
(Choice A) Paying a Year 1 declared dividend in Year 2 is an equity transaction, not an expense. It has no effect on either cash basis or accrual basis NI in Year 1 or Year 2.
(Choice B) Unlike accrual accounting, cash basis does not recognize expected credit losses because only collected sales are recognized as revenue. Therefore, accrual basis NI (for Year 1 and Year 2) is lower because of credit-loss expense. When accounts receivable are written off in Year 2 under accrual accounting, the allowance, not the expense, for credit losses is debited.
(Choice D) A sale of used equipment for cash at a gain in Year 2 has no relation to cash basis NI in Year 1. The sale is recorded in Year 2 under both cash basis and accrual basis accounting.
Things to remember:
When converting cash basis net income (NI) to accrual basis NI, adjustments are required to include revenues earned and expenses incurred, regardless of when cash is received or paid. A decrease in an accrued expense from a prior period will result in a higher NI under accrual basis accounting because it was paid to reduce a liability, not to record an expense.
When a CPA is preparing financial statements under a special purpose framework, it is important for the CPA to remember that
A. GAAP financial statement titles should be used.
B. The basis of accounting should be easily identifiable.
C. The financial statements must still conform with GAAP.
D. The financial statement titles must be modified.
B. The basis of accounting should be easily identifiable.
Financial statements prepared using the income tax basis of accounting should
A. Provide a reconciliation of accrual-basis income to tax-basis income.
B. Recognize revenue when earned, regardless of when cash is received.
C. Report long-term assets at their fair value.
D. Use the direct write-off method to record credit losses.
D. Use the direct write-off method to record credit losses.
Under federal tax regulations, the direct write-off method should be used to record credit losses on income tax returns (ie, specific customer accounts are written off when deemed uncollectible). Therefore, income tax basis F/S should use the direct write-off method for credit losses as well.
(Choice A) Entities reporting under an SPF do not need to adhere to or reconcile with GAAP (ie, the accrual basis of accounting).
When a set of financial statements is prepared using the cash basis or the modified cash basis of accounting, which one of the following is least likely to be an appropriate financial statement title?
A. Statement of Cash Receipts and Cash Disbursements.
B. Balance Sheet.
C. Income Statement.
D. Statement of Financial Position.
C. Income Statement.
When the cash basis or the modified cash basis of accounting is used, the title Income Statement, which is appropriate when the accrual basis of accounting is used, should be replaced by the title Statement of Cash Receipts and Cash Disbursements. This helps distinguish that the statement is not based on full accrual accounting consistent with U.S. GAAP.
In financial statements prepared on the income tax basis, how should the nondeductible portion of expenses such as meals and entertainment be reported?
A. Included in the expense category in the determination of income.
B. Included in a separate category in the determination of income.
C. Excluded from the determination of income but included in the determination of retained earnings.
D. Excluded from the financial statements.
A. Included in the expense category in the determination of income.
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Gen Purpose Financial Reporting For-Profit business12
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Gen Purpose Fin Reporting NFPs35
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Public Company Reporting13
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Special Purpose Frameworks14
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FS Ratios and Performance Metrics10
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Trade Receivables22
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Inventory30
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Property, plant, and equipment14
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Investments26
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Payables and accrued liabilities16
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Debt18
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Equity24
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Accounting changes and error corrections13
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Contingencies and Commitments9
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Revenue Recognition16
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Accounting for Income Taxes10
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Fair Value Measurements10
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Lessee Accounting21
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FAR Memorization25
