Financial 2 - Special Purpose Frameworks

Question 1

Understanding Cash Basis vs. Accrual Basis

Answer 1

• Increase in AR means Sales Revenue is recorded by accrual basis during the year has not yet been paid by the customers. *Under cash basis, revenue is not recorded until the cash has been received
  
  • Therefore, the sales revenue is NOT included in the cash basis, but IS included in the accrual basis
• Decrease in AP means the total cash payments to vendors during the year exceeded the current period’s accrual basis expenses. *Under cash basis, expenses are recorded when payment is made
  
  • Therefore, if the AP balance decreases, the expenses would already be included in the cash basis, and the difference would need to be added back to the accrual basis total. The difference between the cash basis and the accrual basis is the excess cash payments made to vendors
• Net decrease in AR means cash collected exceeds revenue recognized on the accrual basis = Higher cash basis income than accrual basis
• Net decrease in accrued expenses means cash paid to reduce Accrued expenses was more than the accrual basis expense recorded = higher expense under the cash basis than accrual basis

Question 2

Operating Expenses

Answer 2

• An increase in accrued liabilities represents operating expenses which have been incurred or used but not paid
• An increase in the prepaid expenses represents operating expenses which have been paid but not yet used or incurred. To get the amount paid for operating expenses, the increase of prepaids must be added to the operating expenses. Increase in prepaid account = cash payment of operating expense not recorded as a debit to operating expenses

Question 3

Income Tax Basis Financial Statements

Answer 3

• Income tax basis FS recognize events when taxable income or deductible expenses are recognized on the entity’s tax return (period specific). Non-taxable and non-deductible expenses are shown on the FS and included in the determination of income
• Non-deductible expenses should be included in the expense category in the determination of income

How to report Non-Tax Items

• Separate line items in the revenue and expense sections of the statement of revenues and expenses
• Additions and deductions to net income
• A disclosure in the notes

Question 4

Other Comprehensive Basis of Accounting (OCBOA) Financial Statements

Answer 4

• OCBOA financial statement titles should differentiate the FS from accrual basis FS
• OCBOA FS disclosures should be similar to GAAP FS disclosures
• OCBOA FS report equity interests and should explain changes to equity account during the period
• OCBOA FS should include FS equivalent to the accrual basis BS and Income statement. Cash flow not required

Examples of Cash Basis FS:
1. Statement of Cash and Equity
2. Statement of Assets and Liabilities arising from Cash Transactions (modified cash basis)
Examples of Income Tax Basis FS:
1. Statement of Income Tax
Examples of Accrual Basis FS:
1. Statement of Financial Position

Question 5

Modified Cash Basis Financial Statements

Answer 5

Common Modifications to the Modified Cash Basis FS:

1. Recording long-term liabilities
2. Accrual of income taxes
3. Capitalization of Inventory
4. Capitalizing and Depreciating fixed assets
5. Reporting investments at fair value

Accrual basis activity NOT a modification of this FS
EXAMPLE: Recognizing Revenues when earned (this is an accrual activity)

Question 6

Converting Cash Basis FS to Accrual Basis FS

Answer 6

Revenue Recognition

• CASH: Cash Received
• ACCRUAL: Realized or realizable and earned (Accts Rec.)

Expense Recognition

• CASH: Cash Paid
• ACCRUAL: Incurred/owed/benefit received (Accts Pay.)

PASS KEY: The process of converting from cash basis IS to accrual basis IS is the OPPOSITE of the process used to prepare the statement of cash flows from the accrual basis financial statements. If you understand how to prepare the operating section of the statement of cash flows, then you can reverse those calculations to convert cash basis revenues and expenses to accrual basis.

Formulas
- Cash to Accrual REVENUE:
Cash Basis revenue
ADD: Ending AR
LESS: Beginning AR
LESS: Ending Unearned Revenue
ADD: Beginning Unearned Revenue
Accrual Basis Revenue

- Cash Paid for Purchases to COGS:
Cash paid for purchases
ADD: Ending AP
LESS: Beginning AP
LESS: Ending Inventory
ADD: Beginning Inventory
COGS

- Cash Paid for Operating Expenses to Accrual Basis Operating EXPENSES
Cash paid for Operating Expenses
ADD: Ending Accrued Liabilities
LESS:Beginning Accrued Liabilities
LESS: Ending Prepaid Expenses
ADD: Beginning Prepaid Expenses
Accrual Basis Op Ex