University of Phoenix, School of Business Accounting
This week’s activity illustrates the role a company’s accounting method plays in financial statement reporting. In this assignment, I will evaluate the events occurring in a business setting and determine how to properly analyze those events to identify the impact on both cash and accrual accounting methods. I was tasked with preparing a memo, as the senior accountant, to notify the Chief Financial Officer of the delayed wage payments. The compiled messages below are examples provided from the course textbook along with other outside sources.
Memo to the Chief Financial Officer
To: Management-Biz Con
Subject: Delayed payment of wages Dear Sir,
I would like to bring to your attention that the company has been expanding rapidly. To achieve this growth, we have offered a credit period of 6 months to our largest suppliers. Due to this effort, the liquidity of the company is affected. Our equipment manufacturers demand upfront payment and we also had to pay 2 years of insurance. Due to negligible cash inflow and heavy cash outflows, the company is facing a cash crunch. The wages of employees are due, however, we will only be in a position to pay these after some of our payments are received within the first week of next year.
In the first case, even though BizCon will record sales under accrual method, since no cash inflow takes place there will be no entry under cash basis accounting. The cash basis of accounting recognizes revenues when cash is received and recognizes expenses when cash is paid out. For example, a company could perform work in one year and not receive payment until the following year. Under the
cash basis, the revenue would not be reported in the year the work was done but in the following year when the cash is actually received. (ER Services, n.d.)
If we follow cash based accounting means only when the physical cash has been received or moved we will recognize the entry which will not correctly state the financial position of the operations. But as per accrual basis cash receipt and payment are not considered for recognizing entry and whenever the liability incurs or when the asset is accrued for us we will recognize which will accurately presents the financial position of the operation.
Because the cash basis of accounting does not match expenses incurred and revenues earned in the appropriate year, it does not follow Generally Accepted Accounting Principles (GAAP). The cash basis is acceptable in practice only under those circumstances when it approximates the results that a company could obtain under the accrual basis of accounting. For example, in cash based accounting system the salaries paid to employees for one month will be paid in next year which will be recorded in next year as cash has been paid in the next year which will increase the current year profit by decreasing the current year expense. But as per accrual basis even though we pay next year the liability has been incurred in the current year and will be recognized in the current year. So, for the above transactions which includes sales which we receive money later this year also should be recorded in books as accounts receivable in this year as sale has been made in this year and salaries expense also to be booked in the current year as salaries expense and salaries payable. (ER Services, n.d.)
BizCon has been giving six months credit period to the customers and paying to suppliers through cash whenever we are purchasing, this short of cash problem will appear. As we are performing better that is making profit in every sale we will be having better net income but due to non-receipt of cash from customers for sale made due to the extended credit period of six months the short of cash will be having. But in the future if we decrease the credit period we will have the better cash in hand.
Jazmin Pierce, Senior Accountant.
Previously, we demonstrated that financial statements more accurately reflect the financial status and operations of a company when prepared under the accrual basis rather than the cash basis of accounting. The periodicity assumption requires preparing adjusting entries under the accrual basis.
Without the periodicity assumption, a business would have only one time period running from its inception to its termination. Then, the concepts of cash basis and accrual basis accounting would be irrelevant because all revenues and all expenses would be recorded in that one time period and would not have to be assigned to artificially short periods of one year or less. (ER Services, n.d.)
ER Services. (n.d.). The Accrual Basis and Cash Basis of Accounting. Retrieved from ER Services: https://courses.lumenlearning.com/suny-finaccounting/chapter/the-accrual-basis-and-cash- basis-of-accounting/
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