Question

Mr. Sage, the owner, is applying to a local bank for a substantial loan to remodel his store.  The bank requires GAAP based financial statements, but he has always kept the company's records on a cash basis.  He doesn't see why the bank requires GAAP based financial statements.

He recently shouted at top of his lung "After all, I collect cash from customers, pay my bills in cash, and  I am going to pay the bank loan with cash.  I already show my building and equipment as assets and depreciate them.  I just don't understand the problem."

Mr. Cowart, your boss, asked you to explain him the difference between cash basis and accrual basis.and to persuade him to respond to the bank's request.

1. What is a good example for this store to show the difference between cash basis and accrual basis? (3 points)

Imagine a transaction that could possibly take place in the store.  

Try to compare different impacts between cash basis and accrual basis.

You may use a journal approach, a T account approach, BASE(ball) approach, or any other logical method.

2. How would you persuade or dissuade Mr. Sage to respond to the bank's request? (2 point)

Would you persuade or dissuade him to respond to the bank's request?

What is your reasoning? Do you have a better idea for financing? Do they miss any important considerations for the financing?

Answer 1

The basic difference between cash and accrual accounting lies in the timing of when sales and purchases are recorded in your accounts. Cash accounting recognizes revenue and expenses only when money changes hands, but accrual accounting recognizes revenue when it's earned, and expenses when they're billed (but not paid).

1. Example in relation to differentiate two types of accounting:

a. In relation to Sales- Despite cash sales, the store also will be having some credit sales where the present cash system fails to record. But the same needs to be recorded to have a track of receivables. Hence accrual system is required

b. In relation to Purchase & other bill payments- In the cash system of accounting only cash purchases and payments are recorded but whereas all credit transactions are left unrecorded. So by following accrual system, it ensures correct accounting of accounts payables & inventory management.