P1–2 Accrual income versus cash flow for a period Thomas Book Sales, Inc., suppl
ID: 2821015 • Letter: P
Question
P1–2 Accrual income versus cash flow for a period Thomas Book Sales, Inc., supplies
textbooks to college and university bookstores. The books are shipped with a proviso
that they must be paid for within 30 days but can be returned for a full refund
credit within 90 days. In 2014, Thomas shipped and billed book titles totaling
$760,000. Collections, net of return credits, during the year totaled $690,000. The
company spent $300,000 acquiring the books that it shipped.
a. Using accrual accounting and the preceding values, show the firm’s net profit for
the past year.
b. Using cash accounting and the preceding values, show the firm’s net cash flow
for the past year.
c. Which of these statements is more useful to the financial manager? Why?
Interest versus dividend income During the year just ended, Sharing Distributors,
Inc., had pretax earnings from operations of $490,000. In addition, during the year
it received $20,000 in income from interest on bonds it held in Zig Manufacturing
and received $20,000 in income from dividends on its 5% common stock holding in
Tank Industries, Inc. Sharing is in the 40% tax bracket and is eligible for a 70% dividend
exclusion on its Tank Industries stock.
a. Calculate the firm’s tax on its operating earnings only.
b. Find the tax and the after-tax amount attributable to the interest income from
Zig Manufacturing bonds.
c. Find the tax and the after-tax amount attributable to the dividend income from
the Tank Industries, Inc., common stock.
d. Compare, contrast, and discuss the after-tax amounts resulting from the interest
income and dividend income calculated in parts b and c.
e. What is the firm’s total tax liability for the year?
Explanation / Answer
(1) Accrual Accounting refers to the practice of recognizing revenue and expenses as and when they are earned and incurred respectively, irrespective of the timing of the actual cash inflow/outflow.
(a) Recognized Revenue = Total of Shipped and Billed Books = $ 760000 and Cost of Goods Sold(Acquisition Cost of the books shipped) = $ 300000
Net Profit = Recognized Revenue - Cost of Goods Sold = 760000 - 300000 = $ 460000
(b) Cash Inflow (Collections net of return refund credit) = $ 690000 and Cash Outflow (Cost of Goods Sold) = $ 300000
Net Cash Flow = Cash Inflow - Cash Outflow = 690000 - 300000 = $ 390000
(c) The cash flow figure is more important and insightful to financial managers as compared to the net income figure, because the former is a measure of the actual economic benefit accruing to the firm whereas the latter is only an accounting (on the account books) benefit which is intangible in nature. In fact, many firms have positive net income figures but negative cash flows values as line items such as changes in working capital, capital expenditures, non-cash charges etc make the accounting profit (net income) negative. Even in this context the net income measure fails to recognize the return refunds impact on the net wealth (net cash flow) accruing to Thomas Book's.
NOTE: Please raise a separate query for the solution to the remaining unrelated question.
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