Question

BizCon, a consulting firm, has just completed its first year of operations. The com- pany’s sales growth was explosive. To encourage clients to hire its services, BizCon offered 180-day financing—meaning its largest customers do not pay for nearly 6 months. Because BizCon is a new company, its equipment suppliers insist on being paid cash on delivery. Also, it had to pay up front for 2 years of insurance. At the end of the year, BizCon owed employees for one full month of salaries, but due to a cash shortfall, it promised to pay them the first week of next year.Required:(a) Explain how cash and accrual accounting would differ for each of the events listed above and describe the proper accrual accounting.(b) Assume that at the end of the year, BizCon reported a favorable net income, yet the company’s management is concerned because the company is very short of cash. Explain how BizCon could have positive net income and yet run out of cash.

Answer 1

Cash and accrual accounting differ in how they record financial transactions. BizCon could have positive net income but run out of cash due to timing differences.

Step-by-step explanation:

(a) Cash and accrual accounting differ in how they record and recognize financial transactions. Cash accounting records transactions when cash is received or paid out, while accrual accounting records transactions when they are earned or incurred, regardless of when cash is received or paid out. In the case of BizCon, cash accounting would record sales when cash is received from clients, while accrual accounting would recognize sales when they are earned, regardless of when cash is received.

(b) BizCon could have positive net income but run out of cash due to timing differences between when revenue is recognized and when cash is received. For example, if BizCon's clients take advantage of the 180-day financing and delay payment, the company may have earned revenue on paper but not have enough cash on hand to cover its immediate expenses.

Answer 2

Answer: Please refer to Explanation

Step-by-step explanation:

a) When using the Cash accounting method, entries are only made on the books when cash is transacted. That means that if cash is transacted for a transaction I another period than it occurred, it will be recorded in the other period. This therefore does not accurately depict financial statements as entries need to be made in the period they occur.

From the above, salaries will only be paid next year and under the Cash Accounting system will only be recorded next year as well. Insurance will only be recorded this year and not apportioned over 2 years to reflect the periods it was paid for. This is not proper Accounting as it can inflate or deflate income.

Accrual Accounting on the other hand ensures that entries are made in the period they are recognized which has the effect of ensuring that income is properly reported. In the above scenario and under this Accounting style, Salaries will be expensed in the current year whilst insurance will be apportioned across two years.

b) Net Income is calculated with the inclusion of sales whether they be cash sales or credit sales. The text tells of how the company has a 180-day financing rule which allows for clients to pay in 6 months. This means that while they record in the books that they have sold their services, that doesn't mean that they have received payment for the services in the current period. Seeing as they also paid for Equipment upfront as well as Insurance, they had a lot of cash Outflow that was probably not offset by any inflow due to the clients not having paid them yet.