Question

Part 1 Describe why you think accrual accounting helps the reader of financial statements better understand a company's financial position, compared to cash basis accounting. Include in your answer a description of the matching concept and provide an example, taken from class lecture or assigned problems, of a transaction that honors the matching concept. It may help you to consider how net income is impacted by recorded revenue when it is earned rather than when cash is collected, Part 2 How is net income connected to retained earnings and how does the Statement of Retained Earnings help the reader of financial statements understand a company's past performance? What could you conclude about a company who ended their 3 year of operations with a Net Loss of S20,000 but that has an ending balance in retained earnings of $50,000? Describe a scenario that could explain how these results are possible

Answer 1

1.

Accrual accounting system

in the above accounting system , income & expense are recognised when they are done.

it includes all income or expense earned for the period

Cash accounting system

in the above accounting system , income &expense are only recognised in cash.

it includes only cash income earned or expense incurred

for example:

if the cash basis bookkeeper by mistake enter , say, a revenue inflow as $10000 where the correct value is $5000

In a single entry cash system , the error may not be apparent until the fir receives a bank statement . Therefore account balance will reflect either low or overdrawn.

In accrual accounting system, entry of revenue will be accompanied by other entry , say, accounts receivable or bank loan etc.

If the second entry is missing , the sum of debit/credit entries will not match & therefore revealing the error.

2.

net income= profit/losses earned for a period of time

retained earnings= cumulative net income - dividend paid to shareholders

retained earnings is cumulative income which is reinvested back in the company after paying off dividend to shareholders,

which helps the reader to understand that how much a company has earned in the past and present.

A company who ended their 3rd year operations with a net loss of $20000,

reflects that in the third year company incurred loss however retained earnings ending balance shows $50000 which depicts that

company has earned a hight profit in past two years , (approx $70000) and that to

after paying dividend to shareholders, it has also beared current year loss , after which it has positive balance of $50000/-