On pages 155 to 156 answer the following questions and check yourself on pages 175-176
- Page 157 question #5
LO6–Methods of Accounting: Cash, Modified Cash, and Accrual–WATCH THIS VIDEO FIRST
(See Figure 5-24 and Figure 5-25)
- Accrual basis of accounting
- Revenues are recorded when earned.
- A service is provided.
- A product is sold.
- A receivable is created if payment is not yet received.
- Expenses are recorded when incurred.
- A service is received.
- An asset is consumed.
- A payable is created if a service is not yet paid for.
- Measures income best for most businesses.
- Cash basis of accounting
- Revenues are recorded when cash is received.
- Expenses are recorded when cash is paid.
- Does not recognize prepaid assets or long-term assets.
- Modified cash basis of accounting
- Uses the cash basis for recording revenue and expenses.
- Assets acquired other than cash are recorded as assets instead of being recorded as expenses.
- Does not account for receivables or for payables for services rendered.
- It is the same as the accrual basis except that receivables and payables are not recorded for revenues and operating expenses.
- By using the modified cash basis, a business can avoid distortions resulting from the purchase of plant assets.
- Choosing an accounting method is an important decision for every business. Most small service businesses use the modified cash basis of accounting because it is workable for them. Such businesses do not want to record revenues for monies they have not received. Manufacturing and merchandising businesses generally use the accrual basis of accounting. Such companies need to match revenues and expenses very accurately. The cash basis of accounting is rarely used in business. Almost all companies have assets other than cash. To record these assets as expenses would not only be impractical but violate the tax laws for many businesses.
In-Class Exercise: Complete Exercises E5-13A and E5-13B–Use the journal tab of this file for this exercise