Question

Jacob is a nutritionalist who is in the process of setting a large group practice. He expects that the group will have gross receipts of $20,000,000 in the first year and grow by 4% each year. In addition to providing nutritional counseling services the group will sell vitamins, DVDs, and small exercise equipment such as hand weights and mats for stretching The revenues for these products is expected to be about 5% of the total revenue earned each year. Jacob's group would like to use the cash method of accounting if allowed.

Required:
Prepare a memo discussing whether Jacob's group will be able to use the cash method of accounting.

Answer 1

As the company is offering 95% services of total sales, the company can use cash accounting but it is better that we use accrual accounting as it will be used in the future because the firm is growing with good numbers and by law we have to follow the accrual accounting.

Step-by-step explanation:

Cash Accounting:

• Sales and Expenses recorded when they are received or paid. This is against the matching principle which says that the expenses say $50 associated with sales of say $100 must be recorded in the same year.
• It is also not recommended by the International Financial Reporting Standards and GAAP (Generally accepted principles).
• Mostly used by small service organizations or manufacturing organizations with small inventory in stock.
• It confuses the user because it doesn't comply with the matching concept and hence it is possible that the sales of previous year are recorded in the current year due to arrears payments and expenses of current year may be recorded in the previous year because of advance payments.
• The law allows cash accounting for small firms but not for large firms as their stakeholder are in bulk quantities.
• Helpful in seeking loan as it reflects the cash results of the company.

Accrual Accounting:

• Sales and Expenses realized when they are earned or incurred not when they are received or paid. This is as per the matching principle.

• It is also recommended by the International Financial Reporting Standards and GAAP (Generally accepted principles).
• Can be used by any size of organizations because of its meaningful reports. It gives accurate profits and losses calculated and also reflect better balance sheet due to recognition of profits and losses on the basis of matching concept.
• Easily adoptable by the management as it is simple.

Decision:

In my recommendation, the Jacob's group sales are almost $20 million and 5% of these are product sales and the remainder 95% are service sales which shows that the company can use cash accounting as well.

But remember that using cash accounting will not give you meaningful Financial statements and that the accrual accounting will be used in near future due to growth of the company. So it is better now the company adopt accrual basis now.