Question

Which of the following is correct about accrual-basis accounting and cash-basis accounting?

a. Managers can manipulate accruals downward to inflate the firm's net income.

b. If the net income is calculated at the end of a company's economic life, i.e. after the business is wrapped up and liquidated, then the net income calculated using cash-basis accounting is greater than that using accrual-basis accounting.

c. Under accrual-basis accounting, expense is recognized in the same period as the revenue it relates to or in the period to which it is attributable.

d. GAAP gives companies the freedom to use either accrual-basis or cash-basis accounting.

e. Accruals-related accounts include accounts receivable, accounts payable, prepaid expenses, marketable securities, accrued wages, etc.

Answer 1

a. Statement is incorrect for Accrual basis accounting: Managers can manipulate accruals upwards to inflate net income because in accrual basis if accruals or receivables are increased then net income or sales also increase.

Statement is correct for Cash basis accounting: Managers can manipulate accruals downwards to inflate net income because only cash received will be shown as net income.

b. Statement is correct: In cash basis accounting only income received will be shown in net income therefore after liquidation cash is received and in accrual basis accounting income is recorded when activity happens.

c.Statement is correct: In accrual basis of accounting expenses are recognized when it is incurred and if it relates to different periods then recorded for the periods it relates to.

d. Statement is correct: GAAP gives the freedom for companies to use either accrual basis or cash basis accounting.

e. Statement is correct: Accruals means only it is deffered therefore all the above accounts relates to accruals.