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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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    Solution Preview

    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.

    $2.19

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