[Randomness]

I’ve come across two past exam MCQs whose answers seem to contradict each other. Can someone please help me with this…

Q1)

Young & Jamison’s modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?

A. $125,000

B. $135,000

C. $165,000

D. $175,000

According to the text, the answer is C because:

Cash-based operating expenses $150,000

Add the beginning of the year prepaid expenses, 10,000.

Subtract the end of the year prepaid expenses, (15,000).

Subtract the beginning of the year accrued expenses, ( 5,000).

Add the end of the year accrued expenses, 25,000.

Accrual-based operating expenses, $165,000

In this question, for the prepaid asset, you ADD the beginning balance, and SUBTRACT the ending balance. Also for accrued expenses (AKA, a liability, something like wages payable), you SUBTRACT the beginning balance, and ADD the ending balance.

—-

Q2)

A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative Balance Sheet information:

Beginning of year End of year

Accounts payable $ 3,000 $ 1,000

Unearned revenue 300 500

Wages payable 300 400

Prepaid rent 1,200 1,500

Accounts receivable 1,400 600

What amount should the company report as its accrual-based net income for the current year?

A. $68,800

B. $70,200

C. $71,200

D. $73,200

According to the text, the correct answer is C because:

The general rule to convert from cash to accrual is to add the beginning liability balances and subtract the ending liability balances; also, subtract beginning asset balances and add ending asset balances.

This is the exact opposite information as the first questions. Can someone please explain to me what I am missing.

FAR - Studying [4/1/2013 - ???] Test [??/??/????]
AUD - [Who Knows]
REG - [Don't Panic]
BEC - [Can't think that far ahead]

[mangos]

I think the reason it flips is because in one example you're converting INCOME from cash to accrual. The other one you're converting EXPENSES from cash to accrual. So I guess if you were to do these using T-accounts, the sides of the accounts you'd be using would flip.

I learned a trick from someone on the board that makes these pretty easy, and that involves just setting up a journal entry for the increases/decreases in the accounts. For example, for the second question:

DR Cash 70,000

DR AP 2.000 (AP decreased, so you'd debit it)

DR Prepaid Rent 300 (Prepaid went up, so you'd debit it)

CR Accounts Receivable 800 (it decreased, so credit it)

CR Unearned Revenue 200 (went up, so credit it)

CR Wages Payable 100 (went up, credit it)

PLUG Accrual Basis 71,200 (plug figure)

If they're expenses, you'd start off with cash being a credit, and plugging accrual basis as the debit

At least I think that's how it works.

FAR (5/07/13): 96

[mangos]

Here's what I found in another thread:

One thing that used to confuse me on the Cash to Accrual questions was making sure I know what account they are talking about being impacted. It makes a huge difference in determining the change from one to the other.

Example #1 they were looking for the Expenses (Debit Balance) to be adjusted from cash to accrual.

so I do a Taccount beginning with the 150 debit balance:

—if Prepaids increase by 5 that's s DR to prepaid – Credit to Expense

—If the accr. liabilities increase by 20 that's a CR to Liability – Debit to Expense

so Expenses = 150 DR – 5 CR + 20 DR = 165

FAR (5/07/13): 96

[Randomness]

Edit: unfortunately I can't keep the T-Account formatting I created to illustrate the problem. If there are any questions about the info below, just ask.

Hi Mangos. Thanks so much for both posts, they helped me figure out the answers. I created detail notes for myself, and I'm going to post them here…hopefully they can help someone else in the future with the same questions…

Cash to Accrual Conversion

REMEMBER: When converting from cash to accrual, you don’t care what is happening to the cash, you just care about the accrual accounts…the income (Revenue) and Expenses.

The first thing to do is determine if the question is asking about income (revenue) or expense

Q1)Young & Jamison's modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?

A. $125,000 B. $135,000 C. $165,000 D. $175,000

The question is asking about expenses, so must determine the accruals for the expense account (not the cash account).

NOTE: Whatever JE you determine for the account in question, the opposite entry is to an expense account (again, only if the question is asking about operating expenses)

Started year w/ $10,000 in prepaid expenses, & ended w/ $15,000 therefore it increased by $5,000. Prepaid expenses (asset) increase with a debit, therefore the JE for expense is a credit

DR Prepaid Expense 5,000

CR Expense 5,000

[If you want reasoning for above if prepaid asset increased, it means that cash basis expenses decreased by $5,000. We are taking the $5,000 we paid in cash (originally marked as expense), and instead accruing it using a prepaid expense account, to be expensed as it is used later]

Started the year w/ $5,000 accrued liabilities, and ended with $25,000  therefore it increased by $20,000. Accrued liabilities increase with a credit, therefore, the JE for expense is a debit

DR Expense 20,000

CR Accrued Liability 20,000

To find accrual expenses, use the expense JE’s to figure out answer:

Expense

150,000

5,000

20,000

165,000

The answer is $165,000

Q2)A company records items on the cash basis throughout the year and converts to an accrual basis for year-end reporting. Its cash-basis net income for the year is $70,000. The company has gathered the following comparative Balance Sheet information:

Beginning of year End of year

Accounts payable $ 3,000 $ 1,000

Unearned revenue 300 500

Wages payable 300 400

Prepaid rent 1,200 1,500

Accounts receivable 1,400 600

What amount should the company report as its accrual-based net income for the current year?

A. $68,800 B. $70,200 C. $71,200 D. $73,200

The question is asking about revenue, so must determine the accruals for the revenue account (not the cash account).

NOTE: Whatever JE you determine for the account in question, the opposite entry is to an revenue account (again, only if the question is asking about income/revenue)

A/P: Beginning $3,000 & ended with $1,000  A/P decreased by $2,000. Liabilities decrease with a debit, therefore the JE for revenue is a credit

U/R: Beginning $300 & ending $500  U/R increased by $200. Liabilities increase with a credit, therefore the JE for revenue is a debit

W/P: Beginning $300 & ending $400  W/P increased by $100. Liabilities increase with a credit, therefore the JE for revenue is a debit

P/R: Beginning $1,200 & ending $1,500  P/R increased by $300. Assets increase with a debit, therefore the JE for revenue is a credit

A/R: Beginning $1,400 & ending $600  A/R decreased by $800. Assets decrease with a credit, therefore the JE for revenue is a debit

To find accrual income, use the income JE’s to figure out answer:

Revenue

70,000

2,000

200

100

300

800

71,200

Therefore, the answer is $71,200

FAR - Studying [4/1/2013 - ???] Test [??/??/????]
AUD - [Who Knows]
REG - [Don't Panic]
BEC - [Can't think that far ahead]

[cristiangutierrez]

 

Hey Randomnes,

you don't know how much I appreciate your help. I'm preparing for the FAR exam, and I had the same doubt. The textbook provided formulas for the conversion, but they didn't work for that question. Your notes really helped me understand this cash basis to accrual basis conversion.

I can't believe you wrote this 10 years ago and it's still helping others. I hope you passed the exam, and everything went well in your career.

 

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