Question

Listed below are several transactions that took place during the first two years of operations for the law firm of Pete, Pete, and Roy.

Year 1 Year 2
Amounts billed to clients for services rendered $ 180,000 $ 230,000
Cash collected from clients 155,000 185,000
Cash disbursements Salaries paid to employees for services rendered during the year 85,000 95,000
Utilities 27,500 35,000
Purchase of insurance policy 58,500 0
In addition, you learn that the firm incurred utility costs of $32,500 in year 1, that there were no liabilities at the end of year 2, no anticipated bad debts on receivables, and that the insurance policy covers a three-year period.
Required:
1. Calculate the net operating cash flow for years 1 and 2 and determine the amount of receivables from clients that the firm would show in its year 1 and year 2 balance sheets prepared according to the accrual accounting model.
2. Prepare an income statement for each year according to the accrual accounting model.

Answer 1

Income statement for year 1

Service revenue $180,000

Operating expenses:

• Employees salaries $85,000
• Utilities $32,500
• Insurance expense $19,500 $137,000

Net income $43,000

Income statement for year 2

Service revenue $230,000

Operating expenses:

• Employees salaries $95,000
• Utilities $30,000
• Insurance expense $19,500 $144,500

Net income $85,500

Year 1 accounts receivable balance = $180,000 - $155,000 = $25,000

Year 2 accounts receivable balance = $230,000 - $185,000 + $25,000 = $70,000

Cash flows from operating activities year 1:

Net income $43,000

Adjustments to net income:

Increase in accounts payable $5,000

Increase in accounts receivable ($25,000)

Increase in prepaid insurance ($39,000)

Net cash provided by operating activities ($16,000)

Cash flows from operating activities year 1:

Net income $85,500

Adjustments to net income:

Decrease in prepaid insurance $19,500

Increase in accounts receivable ($45,000)

Decrease in accounts payable ($5,000)

Net cash provided by operating activities $55,000