[lz221476]

Compared to the accrual basis of accounting, the cash basis of accounting understates income by the net decreases during the accounting period of:

Account receivable Accrued expenses

a. yes yes

b. yes no

c. no no

d. no yes

Right answer is D. I chose A. My explanation: “Cash basis of accounting understates income”, because it might miss some income which has happened but didn’t receive cash yet, and some expense which has happened may hasn’t been paid yet. So account receivable and accrued expenses both were understated. Anyone can help me find my mistake?

[M.O.D.]

I think mla has the best explanation.

If you receive cash (to reduce AR) you increase cash income, thus overstate it.

If you pay cash (to reduce Accured Expenses) you reduce cash income, thus understate it.

Pretty simplistic scenario though: to ignore the corresponding sales and expense accounts.

BA Mathematics, UC Berkeley
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[mla1169]

Lol. Nothing was ignored. Every transaction has 2 sides.

Receipt of cash (accrual) dr cash cr accounts receivable.

Receipt of cash (cash) dr cash cr revenue

Neither transaction could understate net income.

Payment of cash (accrual) dr accrued expense cr cash

Payment of cash (cash) dr expense cr cash

A debit to expense is the only scenario above that could understate net income.

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[Anonymous]

I guess this is what I don't get about cash basis.

It was my understanding that whenever the payment is made, expense is recorded. Why would there be accrued expense account under cash basis then?

[Anonymous]

@anjanja – Under the Cash Basis there is no accrual of expenses. I didn't read through all of the posts because I saw they were a few months old. Here is a scenario for you that might clear things up:

XYZ receives a bill for electricity on 12/20/13.

Cash Basis

Bill is paid 12/31/13

Dr. Utilities Expense

Cr. Cash

If the bill is paid 1/1/14 then there is no entry in 2013 for that expense. When they pay the bill on 1/1/14 they make the same entry as before, it just impacts the income statement of a different year.

It doesn't matter that they received the bill in 2013, the expense is recognized when they pay the bill.

Accrual Basis

Bill Received 12/20/13

Dr. Utilities Expense

Cr. A/P

It doesn't matter when they pay the bill, the expense is recognized when they receive the bill.

[Anonymous]

Well this is the original question, I don't know maybe I misinterpret it, but it sounds to me that they ask what happens when accrued expenses decrease during the accounting period under the cash basis comparing to accrual. I have no experience with cash basis at all, I wonder maybe accrued expenses are still recorded, but only using balance sheet accounts?

I concluded from some other mcq's on cash basis that there is A/R account even though I didn't think there would be one

Compared to the accrual basis of accounting, the cash basis of accounting understates income by the net decreases during the accounting period of:

Account receivable Accrued expenses

a. yes yes

b. yes no

c. no no

d. no yes

[Anonymous]

Give me a minute. I'm working on something for you.

[Anonymous]

See if this helps.

https://docs.google.com/spreadsheets/d/100HES2K3znfffl6giXtZ9pdk6a6R-DNg5CoP2lZVSG0/edit?usp=sharing

[Anonymous]

Wow thanks! Very helpful! This is kind of what I thought cash basis acct would be. You just put it together?

what about this question? Why would Bob have accounts receivables?

Bob, a consultant, keeps his accounting records on a cash basis. During the current year, Bob collected $200,000 in fees from clients. At December 31st of the previous year, Bob had accounts receivable of $40,000. At December 31st of the current year, Bob had accounts receivable of $60,000, and unearned fees of $5,000. On an accrual basis, what was Bob’s service revenue for the current year?

a

$175,000

b

$180,000

c

$215,000

d

$225,000

[Anonymous]

He wouldn't have an A/R on his financial statements. He just knows how much people owe him.

Give me a few minutes and then go back to the Google Spreadsheet for the rest. I'll make another tab.

[Anonymous]

Check it out again and let me know if that makes sense. I've got to get some supper started but I'll check back later.

[Anonymous]

OK I see. So I guess Bob has a folder with unpaid invoices or something, that represents “A/R”. Unearned would be a payment received for job not yet finished/billed then. Thanks for your help!!!

[Anonymous]

Glad I could help! I'm a visual person when it comes to questions like these. I have to see the T-account or Financial Statements. The bad thing is it ate up a lot of time during testing. Good Luck!

[youness naim]

in cash basis, the cash is increasing ‘revenue' when reducing the AR, so overstating compared to accrual income (because we already recoginized revenue in this basis)
in cash basis, the cash is increasing to ‘expense' when reducing the accrued expense, so understating compared to accrual income (because we already recoginized expense in this basis)

[Author]

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