+/- Accounts with C2A

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  • #816264
    Scared-cpa
    Participant

    I’m having difficulties figuring out whether to add or subtract certain accounts (A/P, A/R, Prepaid, etc.) when I’m converting from cash to accrual basis or vice versa. The nice lady in the CPAexcel lecture videos has t-accounts and equations but I still have difficulty applying them myself when I’m doing exam questions over the topic. For example:

    “Class Corp. maintains its accounting records on the cash basis, but it restates its financial statements to the accrual method of accounting. Class had $60,000 in cash-basis pretax income for 20X2. The following information pertains to Class operations for the years ended December 31, 20X2 and 20X1:
    20X2 20X1
    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, 20X2, Income Statement?”

    The answer is $95,000 (60+21+15) but I pick $65,000 every time because I think that there is extra cash flow since A/R decreased $20,000 during the year, then the company paid out $15,000 in payables.

    Another one I’m doing like that is this:

    “Reid Partners, Ltd., which began operations on January 1, 20X3, has elected to use cash-basis accounting for tax purposes and accrual-basis accounting for its financial statements. Reid reported sales of $175,000 and $80,000 in its tax returns for the years ended December 31, 20X4 and 20X3, respectively. Reid reported accounts receivable of $30,000 and $50,000 in its Balance Sheets as of December 31, 20X4 and 20X3, respectively.

    What amount should Reid report as sales in its Income Statement for the year ended December 31, 20X4?”

    The answer is $155,000 but I keep picking $195,000.

    Any suggestions on helping me fix this bug in my head?

    "The more I practice, the luckier I get."

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Viewing 8 replies - 1 through 8 (of 8 total)
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  • #816408
    leglock
    Participant

    when i was studying the material, the easiest way for me to do these was to always work off of the equation for a cash flow stmt, which you could say converts from accrual to cash.

    With a cash flow stmt (indirect type), you generally start with net income which is accrual based, then you make your adjustments depending on the change in the asset and liability accounts, and what was left was cash basis.

    So you can use basic alegebra to solve these problems based on the equation below by plugging in the numbers they give you and solving for what they ask

    Net Income Accrual
    +/- change in accounts
    ______________________
    Cash Basis Net Income

    So in your first problem, let x be accrual based net income

    x
    -20000 change in a/r
    -15000 change in a/p
    ___________________
    60000 net income cash basis which is given

    x-35000 = 60000
    x=95000

    in your second problem, they want accrual based sales, so x equals accrual based sales

    x
    +20,000 change in a/r
    ________________
    175,000 cash basis sales is given

    x +20000 = 175000
    x=155000

    #818262
    Anonymous
    Inactive

    Anyone else would like to correct me please go ahead, but with problems like these – I've found the interpretation below to work very well for me.

    So your cash-basis is $60,000

    From 20X1 to 20X2, your AR increased by $20,000 – what does it mean? It means you probably accrued Revenue and your J/E goes something like this:

    DR AR 20,000
    CR Revenue 20,000

    Now I'm sure you already know but revenue would increase your accrual-based income, hence the + 20,000 (I also notice you said AR “decreased” – it didn't. So maybe you just misread the question?)

    Next, from X1 to X2, your AP decreased by $15,000 – like you said – this probably because they paid off the liability, most likely with cash. So your J/E goes something like

    DR AP 15,000
    CR Cash 15,000

    So as you can see – because your cash went down $15,000 while paying for liability, you need to add it back to your accrual income. Or think something like this: under cash basis – you paid down 15,000 to arrive at 60,000 – so to convert to accrual, you need to add $15,000 back to your cash-basis income.

    In total that would make 60 + 20 + 15 = 95

    On to the second question –

    Similar approach to the one I explained above, let's think – your reported sales on the tax return which uses a cash-basis acct is $175,000.
    From X3 – X4, AR decreased by $20,000 – meaning, by X4, the company probably have collected the money, so you have an entry like this:

    DR Cash 20,000
    CR AR 20,000

    This means that to arrive at the $175,000 cash income, the company collected $20,000. So in order to convert it back to accrual, you would need to subtract out that $20,000.

    In the end you have 175 – 20 = 155

    Of course, if it all comes down and you just feel like it doesn't make sense (I hope it did) – then there is a choice for memorization technique like an increase in AR = addition to cash basis and vice versa or whatnot – but I would highly not recommend it. It can backfire if you need to convert the other way and mix up the memorization.

    So best of luck!

    #820578
    Scared-cpa
    Participant

    Thanks everyone for your responses! I'm going to thoroughly read over them tonight and try to help myself out.

    Another problem I'm having that I hope you guys can help me with is figuring out whether a bond premium/discount amortization is added or subtracted from net income when working a SCF. I cannot for the life of me figure out if an amortization of bond premium/discount or unamortized bond payables discount/premium is added or subtracted. It just confuses me a lot.

    "The more I practice, the luckier I get."

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    #820950
    komatk2
    Participant

    I had a lot of trouble with Premiums/Discounts on the SCF. A simple way that helped me was considering whether it had a debit/credit balance.

    For a Discount, it has a debit balance. I would just think of it has inventory or a receivable. So if a receivable is decreasing that means you received more cash so it would be an increase to Cash Flow.

    A premium has a credit balance. I would think of it as a liability. So if a payable is decreasing we paid more than we purchased so it would be a decrease to cash flow.

    I hope that helps and makes sense!

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    Done!
    #820977
    Nick_P
    Participant

    Generally speaking, the problems encountered can be solved by remembering the following. When going cash to accrual you add a DB and subtract CR. Opposit going from accrual to cash.

    In the first problem you mentioned we start with Cash and have an increase in an asset (A/R normal debit account) of +20,000 and we have a decrease in a liability (A/P normal credit account) of -15,000. So if we start with cash 60,000 then add the debit account +20,000 and subtract the credit account -15,000 we end up with: 60,000 + 20,000 – (-15,000), that is equal to 60,000 + 20,000 + 15,000 = 95,000

    If we were asked to go from accrual to cash using the same values we would start with 95,000 and subtract the DB and add the CR. 95,000 – 20,000 + (-15,000), that is 95,000 – 20,000 – 15,000 = 60,000 our beginning cash basis amount.

    Do not think this works with every account, but it does work on the ones normally encountered in the MCQs.

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    #821592
    Anonymous
    Inactive

    @scared_cpa
    The easiest way to solve a cash to accrual problem is by using a journal entry:
    Dr. cash 60,000
    Dr. AR (increase) 20,000
    Dr. AP (decrease) 15,000
    Cr. Accrued income 95,000

    #821595
    Anonymous
    Inactive

    @scared_cpa
    For bond discount/premium you must always move towards the face value of the bond.
    So, if a bond is issued at a discount, it is issued at less than the face value. amortization of discount must be added to move towards the face value.
    If the bond is issued at a premium, amortization of the premium must be subtracted to move towards the face value.
    This concept has been explained really well in the becker bonds lecture.

    #822535
    Scared-cpa
    Participant

    Thanks, everyone! I went back and retook the accrual section quiz and got 31 out of 37 correct. Is that considered good for FAR? Is this an appropriate score to aim at as I go forward with individual quizzes per chapter?

    @Amreen, that's really helpful! I'm not the greatest with journal entries (which I know I have to work on since they're covered a lot in the exam), but your explanation helped my brain to actually get it.
    Only one question left: How is this affected if it is the amortization of bonds payable?

    "The more I practice, the luckier I get."

    FAR - 67, 82 (Expires 07/31/18)
    AUD - 68, 79
    REG - 75
    BEC - 82

    Wiley CPAexcel + Ninja

    I cannot believe I am done.

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