[justkeepswimming23]

I always seem to miss the cash basis to accrual questions. Can someone PLEASE explain why a reduction of accounts payable and an increase in accounts receivable adds to income for accrual basis in this problem:

Class Corp. maintains its accounting records on the cash basis but restates its financial statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax income for Year 2. The following information pertains to Class’s operations for the years ended December 31, Year 2 and Year 1:

Year 2 Year 1

Accounts receivable $ 40,000 $ 20,000

Accounts payable 15,000 30,000

Under the accrual method, what amount of income before taxes should Class report in its December 31, Year 2, income statement?

a.) $95,000

b) $65,000

c) $25,000

d.) $55,000

Explanation

Choice “a” is correct. $95,000 accrual income before taxes in the December 31, Year 2, income statement.

Cash-basis pretax income for Year 2 = ……………..$60,000

Increase in accts rec. ($40,000 – $20,000)

(Cash used to pay down prior payables)……………..$20,000

Reduction in accts pay. ($30,000 – $15,000)

(Cash used to pay down prior payables)……………..$15,000

Accrual-basis pretax income for Year 2………………$95,000

FAR: 78
REG: 74, 75
AUD:
BEC:

[marqzho]

Instead of just memorize the +/-, I would always imagine a real company and see the logic. When you make a credit sales, your AR goes up, your cash basis income stays the same and your accrual income goes up.

Let say before the credit sale, you have a $100 cash basis income. Now you are making a $20 credit sale. Your AR goes up by 20. your cash basis income stays the same and accrual basis income goes up by $20.

So you can see, if you want to “translate” from cash to accrual, increase in AR is a plus.

If increase in AR is a plus, decrease in AP is a plus too.

In this question:
cash basis income is $60
Increase in AR +20
Decrease in AP +15
Accrual basis income = $95

REG 90
FAR 95
AUD 98
BEC 84

[Spartans92]

@justkeepswimming, think of it this way you start off with 60,000 dollars. Your AR went up by 20k that means you recognized 20k in sales but have not yet received money. But that doesn't matter under accrual so you book that income. 60k+20k = 80k. Then for the payable it went down 15k. At some point you paid out 15k in bills. You would expensed them under cash basis but under accrual it is irrelevant when you pay them but when you incur. With that said, we paid out 15k but under accrual we should add back that amount. Therefore, 80k + 15k = 95K. Hope that helps. Accrual is all about recognizing revenue and expenses in the period incur (matching principle) and not when cash are paid. Practice more Q's you're going to become an expert at it!

BEC- PASS

[justkeepswimming23]

Marqzho wow make's so much sense now. I couldn't quite get it but got it now, thanks so much!

FAR: 78
REG: 74, 75
AUD:
BEC:

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