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Cash versus accrual accounting

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Cash versus accrual accounting. Jack Block opens a tax and bookkeeping services business, Block's Tax and Bookkeeping Services, on July 1, 2008. He invests $40,000 for all
the common stock of the business, and the firm borrows $20,000 from the local bank, promising to repay the loan on December 31, 2008, along with interest at 8% per year, or approximately $133 per month (5[.08 3 $20,000] / 12 months). The firm rents space on July 1 and pays $6,000 for three months rent in advance, and leases office equipment for the year, prepaying $12,000 for six months rent. The firm hires an office assistant whom it will pay $72,000 per year with payments every two months, issuing the first paycheck on August 31. Finally, the firm pays cash for office supplies during July costing $370; a physical count at the end of July shows that $280 of office supplies are on hand. During July, Block's Tax and Bookkeeping Services performs services and bills customers for $44,000. On July 31, 2008, customers had paid $13,000 of the amount owed.

a. What is income for Block's Tax and Bookkeeping Services for July, 2008:
(1) Applying cash-basis accounting.
(2) Applying accrual accounting.

b. How much cash on hand does Block's Tax and Bookkeeping Services have as of July 31, 2008? Why is the amount of cash on hand not a good representation of the firm's performance during July?

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Solution Summary

The problem analyzes a few transactions for a new business and explains the differences in cash and accrual methods of accounting. It also computes the cash balance at the end of the first month of business and explains the relationship between cash and net income.

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Cash basis accounting records transactions for all cash payments and receipts as expenses or income ignoring the matching principle used in generally accepted accounting principles (GAAP). Accrual accounting, on the other ...

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