Question

A major element of this week's lesson is making sure that you understand how the so-called accrual adjustments "correct" a cash-basis income statement. For this discussion you need to select ONE (1) real-world example of a business circumstance that would reasonably be the basis for an accrual adjustment in an income statement.

Be sure to (a) briefly describe that circumstance, (b) describe what the appropriate adjustment to the cash basis income statement such that it would then represent an accrual basis revenue or expense, and (c) walk through the logic of HOW the adjustment usefully corrects what would have been reflected on a cash basis income statement.

Answer 1

Cash Basis of accounting -

Generally cash basis of accounting is not followed by the businesses. In cash basis of accounting company account all the expenses that are paid and all the incomes that are received in cash.

Accrual Basis of Accounting -

This method of accounting is followed by all the businesses. It is proper way to use cut off procedure as it bifurcate the incomes and expense for the period in which they are incurred. Incomes are booked in this method when they earned. Expenses are booked in this method when they incurred.

If a company followed cash basis of accounting and they need to convert it into Accrual Basis of Accounting. To convert cash basis of records into accrual basis we need to consider following points -

1. If an expenses is paid for the period later than the financial period then we have to transfer that excess portion of next financial in the assets. (Prepaid Expenses)

2. In the cash basis of accounting we have received income which we have not earned yet then to convert into accrual basis we have to transfer that unearned income into current liabilities.

3. Expenses that need to be paid in the current period even if we have not paid it we have to book those expenses as it pertains to current period and add accrued liabilities.

4. Likewise if company has not received income but that income is earned by the entity then we have to make entry for the recognition and in the account receivable.

5. All the advance receipts and advance payment we have to remove and transfer them to balance sheet.

Considering all the above adjustment can convert a cash basis of financial statement to Accrual basis of income statement