Question

After reviewing the financial statements, the loan officer at the bank asked your brother whether he used the accrual basis of accounting for revenues and expenses. Your brother responded that he did, which is why he included an account for “Amounts Due from Customers.” The loan officer then asked whether the accounts were adjusted prior to the preparation of the statements. Your brother answered that they had not been adjusted. a. Why do you think the loan officer suspected that the accounts had not been adjusted prior to the preparation of the statements? b. Indicate the accounts that might need to be adjusted before an accurate set of finan- cial statements can be prepared. c. Why did the loan officer ask your brother whether he used the accrual basis of accounting for revenues and expenses? Why would it have been important to use this method?

Answer 1

Answer:-

a)  The Loan Office is suspected based on following ground :

1) As there is no accumulated depreciation charged for trucks used generating income

2) Net income has not been transferred to retained earning account which adjustment need to be done before preparing financial statement.

b)   The Following are the possible Accounts that need to be adjusted :

1)   Depreciation : Depreciation should be charged to the income statement as expenses and accumulated depreciation need to be reduced from Fixed Asset A/c in balance sheet.

2)   The Net income need to be transferred in Retained Earning A/c and then retained earning need to be grouped under Owner Equity under balance sheet.

c)   Reason to ask whether he used the accrual basis of accounting for revenues and expenses may be :

1)   There is no Sundry creditor in balance sheet .Under Accrual basis we recognize expenses even no amount of cash is paid and same is shown under current liability under balance sheet.

2)   Under Income statement he has considered Insurance premium .Under cash basis entire premium need to be shown under income statement if cash paid in same year whereas under accrual basis Insurance premium need to be booked as expense related with year only and balance need to be transferred under prepaid expenses under the head of current assets under balance sheet.

Importance of use of method : Net income & balance sheet position depend on which method you used fro Accounting

there are two basis of accounting :

1)   Cash basis accounting - under cash basis , A company records all the transactions only when cash inflow / outflow happen with regard to revenue & expenses

2)   Accrual Basis Accounting : A revenue and expense is recorded in books of accounts irrespective of the fact that as to when cash is received/paid.

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