Question

BizCon, a consulting firm, has just completed its first year of operations. The company’s sales growth was explosive. To encourage clients to hire its services, BizCon offered 180-day financing—meaning its largest customers do not pay for nearly 6 months. Because BizCon is a new company, its equipment suppliers insist on being paid cash on delivery. Also, it had to pay up front for 2 years of insurance. At the end of the year, BizCon owed employees for one full month of salaries, but due to a cash shortfall, it promised to pay them the first week of next year.

(a) Explain how cash and accrual accounting would differ for each of the events listed above and describe the proper accrual accounting.

(b) Assume that at the end of the year, BizCon reported a favorable net income, yet the company’s management is concerned because the company is very short of cash. Explain how BizCon could have positive net income and yet run out of cash.

Answer 1

(a) Explain how cash and accural accounting would differ for each of the events listed above and describe the proper accural accounting?

Answer: 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 positionof the operations. But as per accural basis cash recipt and payment are not considered for recognizing entry and whenever the liabilty incurrs or when the asset is accured for us we will recognize which will accurately presents the financial position of the operation.

For example take salaries payment here in the above question: In cash based accouting 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 accural 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 salalries payable.

(b) Assume that at the end of the year, Bizcon reported a favorable net income, yet the company's management is concerned because the company is very short of cash. Explain how bizcon could have net income yet run out of cash?

Answer: As in the question it says that 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.