Question

Q5. Thomas Book Sales, Inc., supplies textbooks to college and university bookstores. The books are shipped with a proviso that they must be paid for within 30 days but can be returned for a full refund credit within 90 days. In 2009, Thomas shipped and billed book titles totaling $760,000. Collections, net of return credits, during the year totaled $690,000. The company spent $300,000 acquiring the books that it shipped.

a. Using accrual accounting and the preceding values, show the firm’s net profit for the past year.

b. Using cash accounting and the preceding values, show the firm’s net cash flow for the past year.

c. Which of these statements is more useful to the financial manager? Why?

Answer 1

a. Using accrual accounting and the preceding values, show the firm’s net profit for the past year.

Revenue accrued (sales) = $760,000

Cost of acquisition = $300,000

Net Profit = $760,000 - $300,000 = $460,000

(Under accrual accounting, sales and purchases are recorded as soon the sales is effected or purchase is made irrespective of whether the revenue will be collected or purchases will be paid).

b. Using cash accounting and the preceding values, show the firm’s net cash flow for the past year.

Collection net of return credits = $690,000

Cost of acquisition (spent)= $300,000

Net Cash Flow = $690,000-$300,000 = $390,000

c. Which of these statements is more useful to the financial manager? Why?

The question does not have the options to ascertain which is more useful. Providing the answer for Net Profit or Net Cash Flow and which is more useful.

For a Finance manager, the cash flow will provide more meaningful insights on the cash position of the company since the net profit (as per accrual) will also have sales that will not be collected. For any major financial or capital budgeting decisions, it is the cash flow that is conidered by Finance managers than the net profit (accounting profit).