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In: Accounting

Profit or Loss Account (Income Statement) of a business shows a net profit of 500,000. The...

Profit or Loss Account (Income Statement) of a business shows a net profit of 500,000. The owner of the business says, ‘Where is the money? My business does not have an increase in cash by $500,000 in the bank account. Where is the $500,000 profit?

Required:

Provide an explanation to the owner of the business about why net profit of a Profit or Loss Account (Income Statement) is not necessarily equal to the cash inflow. Your explanation must include two examples of accounting entries that lead to a difference between net profit of the Income Statement and cash flow of the business.

Solutions

Expert Solution

Net profit is not necessarily equal to the cash inflow, if the business uses accrual basis accounting. Under accrual basis accounting, revenues are recognized when they are earned and expenses are recognized when they are incurred without considering the actual cash payments or receipts.

Examples:

ekkarill92 answered 2 years ago
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