Question

Listed below are several transactions that took place during the first two years of operations for the law firm of Pete, Pete, and Roy.

	Year 1			Year 2
Amounts billed to clients for services rendered	$	178,000		$	228,000
Cash collected from clients		164,000			194,000
Cash disbursements
Salaries paid to employees for services rendered during the year		94,000			104,000
Utilities		32,000			44,000
Purchase of insurance policy		61,200			0

In addition, you learn that the firm incurred utility costs of $37,000 in year 1, that there were no liabilities at the end of year 2, no anticipated bad debts on receivables, and that the insurance policy covers a three-year period.

Required:
1. & 3. Calculate the net operating cash flow for years 1 and 2 and determine the amount of receivables from clients that the firm would show in its year 1 and year 2 balance sheets prepared according to the accrual accounting model.
2. Prepare an income statement for each year according to the accrual accounting model.

Show your steps for each step
  

Answer 1

As per accrual concept, the income and expenses shall be allocate as and when they occur and not when there is cash movement.

Utilities expense shall be reported $ 37,000 in income statement instead of cash $ 32,000 which is used to compute net operating cash flows.

Further insurance policy for $ 61,200 has been taken for 3 years.

Hence, insurance policy of 61,200/3 = $ 20,400 shall be recognized in income statement for both the years.

Requirement 1

Operating cash flows are the net cash obtained from business activities i.e. mainstream purpose.

Computation of operating cash flows

	Year 1	Year 2
Cash collected	$164,000	$194,000
Cash distributed:
Salaries	($94,000)	($104,000)
Utilities	($32,000)	($44,000)
Purchase of insurance policy	($61,200)	0
Net operating cash flow	($23,200)	$46,000

Requirement 3

amount of receivables from clients

	Year 1	Year 2
Beginning account receivable		$14,000
Amount billed	$178,000	$228,000
Less: Cash received	($164,000)	($194,000)
Ending accounts receivable	$14,000	$48,000

Requirement 2

Income Statement

	Year 1	Year 2
Revenues	$178,000	$228,000
Expenses:
Salaries	$94,000	$104,000
Utilities	$37,000	$44,000
Insurance	$20,400	$20,400
Net income/(loss)	$26,600	$59,600

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