(a) What information do accrual-basis financial statements (i.e., the balance sh
ID: 2547358 • Letter: #
Question
(a) What information do accrual-basis financial statements (i.e., the balance sheet and income statements) provide that cash-basis statements (i.e., cash flow statement) do not? Please explain clearly and provide at least one example for balance sheet and one example for income statement.(b) What information do cash-basis financial statements (i.e., the cash flow statement) provide that accrual-basis statements (i.e., the income statement and balance sheet) do not? Please explain clearly how the cash flow statement helps the reader understand the company and provide at least one example from the cash flow statement.
(a) What information do accrual-basis financial statements (i.e., the balance sheet and income statements) provide that cash-basis statements (i.e., cash flow statement) do not? Please explain clearly and provide at least one example for balance sheet and one example for income statement.
(b) What information do cash-basis financial statements (i.e., the cash flow statement) provide that accrual-basis statements (i.e., the income statement and balance sheet) do not? Please explain clearly how the cash flow statement helps the reader understand the company and provide at least one example from the cash flow statement.
(a) What information do accrual-basis financial statements (i.e., the balance sheet and income statements) provide that cash-basis statements (i.e., cash flow statement) do not? Please explain clearly and provide at least one example for balance sheet and one example for income statement.
(b) What information do cash-basis financial statements (i.e., the cash flow statement) provide that accrual-basis statements (i.e., the income statement and balance sheet) do not? Please explain clearly how the cash flow statement helps the reader understand the company and provide at least one example from the cash flow statement.
Explanation / Answer
(A)---The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is mostly used by small businesses and for personal finances. The cash method accounts for revenue only when the money is received and for expenses only when the money is paid out. On the other hand, the accrual method accounts for revenue when it is earned and expenses goods and services when they are incurred. The revenue is recorded even if cash has not been received or if expenses have been incurred but no cash has been paid. Accrual accounting is the most common method used by businesses.
For example: Let's say you own a business that sells machinery. If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check. Under the accrual method, the $5000 is recorded as revenue immediately when the sale is made, even if you receive the money a few days or weeks later. The same thing occurs for expenses. If you get an electric bill for $1700, under the cash method, the amount is not added to the books until you actually pay the bill. However, under the accrual method, the $1700 is recorded as an expense the day you get the bill.
Under the accrual basis of accounting, revenues are reported on the income statement when they are earned. (Under the cash basis of accounting, revenues are reported on the income statement when the cash is received.) Under the accrual basis of accounting, expenses are matched with the related revenues and/or are reported when the expense occurs, not when the cash is paid. The result of accrual accounting is an income statement that better measures the profitability of a company during a specific time period.
For example, if I begin an accounting service in December and provide $10,000 of accounting services in December, but don't receive any of the money from the clients until January, there will be a difference in the income statements for December and January under the accrual and cash bases of accounting. Under the accrual basis, my income statements will show $10,000 of revenues in December and none of those services will be reported as revenues in January. Under the cash basis, my December income statement will show no revenues. Instead, the December services will be reported as January revenues under the cash method.
There will be a difference on the balance sheet, too. Under the accrual basis, the December balance sheet will report accounts receivable of $10,000 and the estimated true profit will be added to owner's equity or retained earnings. Under the cash basis, the $10,000 of accounts receivable will not be reported as an asset, and the true profit will not be included in owner's equity or retained earnings.
To illustrate a difference in expenses, we will assume that the heat and light expense that I used in my accounting service is metered by the utility on the last day of the month. The utilities that I used in December will appear on a bill that I receive in January and will pay on February 1. Under the accrual basis of accounting, the utilities that I used in December will be estimated and will be reported as an expense and a liability on the December financial statements. Under the cash basis of accounting, the utilities used in December will be recorded as an expense on February 1, when the utility bills are paid.
For financial statements prepared in accordance with generally accepted accounting principles, the accrual method is required because of the matching principle.
Income statement is a company’s financial statement that indicates how the revenue is transformed into the net income.
LEARNING OBJECTIVES
Indicate the purpose of the income statement
KEY TAKEAWAYS
Key Points
Income statement displays the revenues recognized for a specific period, and the cost and expenses charged against these revenues, including write-offs and taxes.
The income statement can be prepared in two methods. The Single Step income statement takes a simpler approach, totaling revenues and subtracting expenses to find the bottom line. The Multi-Step income statement takes several steps to find the bottom line, starting with the gross profit.
(B)---A Cash Flow Statement (also called the Statement of Cash Flows) shows how much cash is generated and used during a given time period. It is one of the main financial statements analysts use in building a three statement model. The main categories found in a cash flow statement are the (1) operating activities, (2) investing activities and (3) financing activities of a company and are organized respectively as mentioned. The total cash provided from or used by each of the three activities will be summed to arrive at the total change in cash for the period, and then combined with the opening cash balance to arrive at the cash flow statement’s bottom line, the closing cash balance.
Cash Flow Statement
A reconciliation of the cash generated and used in a period
Resources > Knowledge > Accounting > Cash Flow Statement
What is the Cash Flow Statement?
A Cash Flow Statement (also called the Statement of Cash Flows) shows how much cash is generated and used during a given time period. It is one of the main financial statements analysts use in building a three statement model. The main categories found in a cash flow statement are the (1) operating activities, (2) investing activities and (3) financing activities of a company and are organized respectively as mentioned. The total cash provided from or used by each of the three activities will be summed to arrive at the total change in cash for the period, and then combined with the opening cash balance to arrive at the cash flow statement’s bottom line, the closing cash balance.
One of the primary reasons cash inflows and outflows are observed is to compare the cash from operations to net income to gauge how well a company is running its operations. The cash flow statement reflects the actual amount of money the company receives from its profits. The reason for the difference between cash and profit is because the income statement is prepared under the accrual basis of accounting, where it matches revenues and expenses, even though revenues may actually not have been collected and expenses may not have been paid.
Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement.
Here are a few ways the statement of cash flows is used.
1)-The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
2)-Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value.
3)-Some financial models are based upon cash flow.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.