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Cash vs Accrual Accounting

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M3-2 Reporting Cash Basis versus Accrual Basis Income
Mostert Music Company had the following transactions in March:
a. Sold instruments to customers for $10,000; received $6,000 in cash and the rest on account.
The cost of the instruments was $7,000.
b. Purchased $4,000 of new instruments inventory; paid $1,000 in cash and owed the rest on
account.
c. Paid $600 in wages for the month.
d. Received a $200 bill for utilities that will be paid in April.
e. Received $1,000 from customers as deposits on orders of new instruments to be sold to the
customers in April.
Complete the following statements:

1. The matching principle controls
a. Where on the income statement expenses should be presented.
b. How costs are allocated between Cost of Goods Sold (sometimes called Cost of Sales)
and general and administrative expenses.
c. The ordering of current assets and current liabilities on the balance sheet.
d. When costs are recognized as expenses on the income statement.
2. Which of the following would not be considered a recurring item on the income statement?
a. Administrative expenses. c. Selling expenses.
b. Sales revenues. d. Loss on disposal of a business division.

3. Define accrual accounting and contrast it with cash basis accounting.
4. What four conditions must normally be met for revenue to be recognized under accrual basis
accounting?

P1-3A On June 1 Fix-It-Up Service Co. was started with an initial investment in
the company of $26,200 cash. Here are the assets and liabilities of the company at
June 30, and the revenues and expenses for the month of June, its first month of
operations:
Cash $ 4,600 Notes payable $14,000
Accounts receivable 4,000 Accounts payable 500
Revenue 8,000 Supplies expense 1,000
Supplies 2,400 Gas and oil expense 600
Advertising expense 400 Utilities expense 300
Equipment 32,000 Wage expense 1,400
In June, the company issued no additional stock, but paid dividends of $2,000.
Instructions
(a) Prepare an income statement and a retained earnings statement for the month of
June and a balance sheet at June 30, 2007.
(b) Briefly discuss whether the company's first month of operations was a success.
(c) Discuss the company's decision to distribute a dividend.

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M3-2 Reporting Cash Basis versus Accrual Basis Income
Mostert Music Company had the following transactions in March:
a. Sold instruments to customers for $10,000; received $6,000 in cash and the rest on account.
The cost of the instruments was $7,000.
b. Purchased $4,000 of new instruments inventory; paid $1,000 in cash and owed the rest on
account.
c. Paid $600 in wages for the month.
d. Received a $200 bill for utilities that will be paid in April.
e. Received $1,000 from customers as deposits on orders of new instruments to be sold to the
customers in April.
Complete the following statements:

In the cash basis, we record only the transactions when cash is paid or received.

Cash Basis Income Statement
Revenues:
Cash Sales 6,000
Customer Deposits 1,000
Expenses
Inventory Purchases 1,000
Wages Paid 200
Cash Income 5,800

In accrual basis we record revenue which is earned and expenses which are incurred.
Accrual Basis Income Statement
Sales to Customers 10,000
Expenses
Cost of Sales 7,000
Wages Expense 600
Utilities Expense 200 7,800
Net Income 2,200

1. The matching principle controls
a. Where on the income statement expenses should be presented.
b. How costs are allocated between Cost of ...

Solution Summary

The solution explains how to record transactions under cash accounting and accrual accounting. It also explains the conditions to be fulfilled for revenue recognition and the preparation of financial statements given a set of transactions.

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