1. ACCOUNTING FUNDAMENTALS FOR MANAGERS
University of Management and Technology
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2. Task Force Clip Art included in this electronic presentation is used with the permission of New Vision Technology of Nepean Ontario, Canada.

3. The Cash Basis of Accounting
Chapter 2
The Cash Basis of Accounting

4. After studying this chapter, you should be able to:
Learning Objectives
Describe the basic elements of a financial accounting information system.
Describe the cash and accrual bases of accounting.
Use the cash basis of accounting to analyze, record, and summarize transactions for a corporation’s first period of operations.
Use the cash basis of accounting to prepare financial statements for the first period of operations.
After studying this chapter, you should be able to:
Continued

5. Learning Objectives
Use the cash basis of accounting for recording transactions and preparing financial statements for a second period of operations.
Describe the advantages and disadvantages of the cash basis of accounting.
Describe and illustrate how vertical analysis can be used to analyze and evaluate a company’s performance.

6. Learning Objective 1
Describe the basic elements of a financial accounting information system.

7. Stock-holders’ Equity
Balance Sheet
Assets =
Liabilities
Stock-holders’ Equity +
The Accounting Equation
The rights of creditors
The rights of the stockholders

8. 2 Describe the cash and accrual bases of accounting.
Learning Objective 2
Describe the cash and accrual bases of accounting.

9. Under the cash basis of accounting, a business records only transactions involving increases or decreases in cash.

10. Under the accrual basis of accounting, revenue is recorded as it is earned and an expense is recorded when incurred.

11. Learning Objective 3
Use the cash basis of accounting to analyze, record, and summarize transactions for a corporation’s first period of operations.

12. On September 1, 2003, Dr. Lee Landry organized a professional corporation to practice general medicine.

13. a. Dr. Landry deposits $6,000 in a bank account in the name of Family Health Care, P.C. in return for shares of stock in the corporation.
Assets =
Stockholders’ Equity
Cash
6,000
Capital
Stock
6,000 Investment by Dr. Landry a.

14. b. Family Health Care borrowed $10,000 from First National Bank.
Stockholders’ Equity
Assets =
Liabilities +
Cash
6,000
Notes Payable +
Capital
Stock
6,000 = a.
b. 10,000 10,000
Bal. 16,000 10,000 6,000

15. c. Family Health Care buys land for $12,000 cash.
Stockholders’ Equity
Assets =
Liabilities +
Cash
+ Land
Notes Payable +
Capital
Stock =
Bal. 16, ,000 6,000
c. –12,000 12,000
Bal. 4,000 12,000 10,000 6,000

16. d. During the first month of operations, Family Health Care earns patient fees of $5,500, receiving the amount in cash.
Stockholders’ Equity
Assets =
Liabilities +
Cash + Land
Notes Payable +
Capital
Stock
Retained Earnings =
Bal. 4,000 12,000 10,000 6,000
d. 5,500 Revenue  5,500
Bal. 9,500 12,000 10,000 6,000 5,500

17. e. The expenses for the month were as follows: wages, $1,125; rent, $950; utilities, $450; interest, $100; miscellaneous, $275.
Stockholders’ Equity
Assets =
Liabilities +
Cash + Land
Notes Payable +
Capital
Stock
Retained Earnings =
Bal. 9,500 12,000 10,000 6,000 5,500
e. –2,900 Wages expense  –1,125
Rent expense  –950
Utilities expense  –450
Interest expense  –100
Misc. expense  –275
Bal. 6,600 12,000 10,000 6,000 2,600

18. f. Family Health Care pays $1,500 to stockholder (Dr
f. Family Health Care pays $1,500 to stockholder (Dr. Landry) as dividends.
Stockholders’ Equity
Assets =
Liabilities +
Cash + Land
Notes Payable +
Capital
Stock
Retained Earnings =
Bal. 6,600 12,000 10,000 6,000 2,600
f. –1,500 Dividends  –1,500
Bal. 5,100 12,000 10,000 6,000 1,100

19. The following apply to all types of businesses:
1. The effect of every transaction is an increase or a decrease in one or more of the accounting equation elements.
2. The two sides of the accounting equation are always equal.
3. The stockholders’ equity is increased by amounts invested by stockholders and by revenues. It is decreased by expenses and dividends.
Let’s visualize this.

20. Stockholders’ Investments
STOCKHOLDERS’ EQUITY
Capital Stock
Retained Earnings
Stockholders’ Investments
INCREASED BY
Revenues
Expenses
Dividends
INCREASED BY
DECREASED BY

21. Learning Objective 4
Use the cash basis of accounting to prepare financial statements for the first period of operations.

22. For the Month Ended September 30, 2003
Family Health Care, P.C.
Income Statement
For the Month Ended September 30, 2003
Fees earned $5,500
Operating expenses:
Wages expense $1,125
Rent expense 950
Utilities expense 450
Interest expense 100
Miscellaneous expense
Total operating expenses 2,900
Net income $2,600
Revenue and expense amounts taken from the Retained Earnings column in Exhibit 2 of the textbook.

23. Retained Earnings Statement For the Month Ended September 30, 2003
Family Health Care, P.C.
Retained Earnings Statement
For the Month Ended September 30, 2003
Net income for September $2,600
Less dividends 1,500
Retained Earnings, September 30, $1,100
The net income is taken from the income statement (previous slide) and the amount of dividends from the Retained Earnings column in Exhibit 2 of the textbook.

24. Family Health Care, P.C.
Balance Sheet
September 30, 2003
All account balances were taken from the bottom row of Exhibit 2, except Retained Earnings.
Assets
Cash $ 5,100
Land 12,000
Total assets $17,100
Liabilities
Notes payable $10,000
Stockholders’ Equity
Capital stock $6,000
Retained earnings 1, ,100
Total liabilities and stockholders’ equity $17,100
Retained Earnings balance is taken from the retained earnings statement.

25. Total assets equal total liabilities plus stockholders’ equity.
Family Health Care, P.C.
Balance Sheet
September 30, 2003
Assets
Cash $ 5,100
Land 12,000
Total assets $17,100
Liabilities
Notes payable $10,000
Stockholders’ Equity
Capital stock $6,000
Retained earnings 1, ,100
Total liabilities and stockholders’ equity $17,100
Total assets equal total liabilities plus stockholders’ equity.

26. Statement of Cash Flows For the Month Ended September 30, 2003
Family Health Care, P.C.
Statement of Cash Flows
For the Month Ended September 30, 2003
Cash flows from operating activities:
Cash received from customers $ 5,500
Deduct cash payments for expenses ,900
Net cash flow from operating activities $ 2,600
Cash flows from investing activities:
Cash payments for acquisition of land (12,000)
Cash flows from financing activities:
Cash from sale of cap. stock $ 6,000
Cash from notes payable 10,000 $16,000
Deduct cash dividends ,500
Net cash flow from financing activities ,500
Net increase in cash $ 5,100
September 1, 2003 cash balance
September 30, 2003 cash balance $ 5,100

27. Learning Objective 5
Use the cash basis of accounting for recording transactions and preparing financial statements for a second period of operations.

28. a. Received fees of $6,400 in cash.
Stockholders’ Equity
Assets =
Liabilities +
Cash + Land
Notes Payable +
Capital
Stock
Retained Earnings =
Bal. 5,100 12,000 10,000 6,000 1,100
a. 6,400 Revenue 6,400
Bal. 11,500 12,000 10,000 6,000 7,500

29. b. Paid expenses in cash as follows follows: wages, $1,370; rent, $950; utilities, $540; interest, $100; miscellaneous, $220.
Stockholders’ Equity
Assets =
Liabilities +
Cash + Land
Notes Payable +
Capital
Stock
Retained Earnings =
Bal. 11,500 12,000 10,000 6,000 7,500
e. –3,180 Wages expense  –1,370
Rent expense  –950
Utilities expense  –540
Interest expense  –100
Misc. expense  –220
Bal. 8,320 12,000 10,000 6,000 4,320

30. c. Family Health Care pays $1,000 to stockholders (Dr
c. Family Health Care pays $1,000 to stockholders (Dr. Landry) as dividends.
Stockholders’ Equity
Assets =
Liabilities +
Cash + Land
Notes Payable +
Capital
Stock
Retained Earnings =
Bal. 8,320 12,000 10,000 6,000 4,320
c. –1,000 Dividends  –1,000
Bal. 7,320 12,000 10,000 6,000 3,320

31. For the Month Ended October 31, 2003
Family Health Care, P.C.
Income Statement
For the Month Ended October 31, 2003
To review the source of this amount, click the green button below.
Fees earned $6,400
Operating expenses:
Wages expense $1,370
Rent expense 950
Utilities expense 540
Interest expense 100
Miscellaneous expense
Total operating expenses 3,180
Net income $3,220
To review the source of expenses, click the orange button below.
Revenue
Expenses

32. Learning Objective 6
Describe the advantages and disadvantages of the cash basis of accounting.

33. The primary advantage of the cash basis of accounting is its simplicity.

34. The primary disadvantage of the cash basis is that revenues and expenses may not be properly matched on the income statement.

35. Learning Objective 7
Describe and illustrate how vertical analysis can be used to analyze and evaluate a company’s performance.

36. Statements can be compared by computing a percentage of each item within a statement to a total within the statement.

37. This type of analysis is called vertical analysis.

38. Vertical Analysis—Balance Sheet
Assets:
Cash and cash equivalents $ 307,785
Short-term investments 25,450
Accounts receivable 239,885
Inventories 278,981
Property, plant, and equipment 684,379
Other assets ,168
TOTAL ASSETS $1,765,648
17.4%
$307,785
$1,765,648

39. Vertical Analysis—Balance Sheet
Assets:
Cash and cash equivalents $ 307,785
Short-term investments 25,450
Accounts receivable 239,885
Inventories 278,981
Property, plant, and equipment 684,379
Other assets ,168
TOTAL ASSETS $1,765,648
17.4%
1.4
$25,450
$1,765,648

40. Vertical Analysis—Balance Sheet
Assets:
Cash and cash equivalents $ 307,785
Short-term investments 25,450
Accounts receivable 239,885
Inventories 278,981
Property, plant, and equipment 684,379
Other assets ,168
TOTAL ASSETS $1,765,648
17.4%
1.4
13.6
15.8
38.8
13.0
100.0%

41. Vertical Analysis—Balance Sheet
Liabilities:
Accounts payable $ ,225
Dividends payable 42,741
Income and other taxes payable 68,467
Long-term liabilities 157,127
Other liabilities ,891
Total liabilities $ 489,451
Stockholders’ equity:
Total stockholders’ equity 1,276,197
TOTAL LIAB. & S.E. $1,765,648
5.2%
$91,225
$1,765,648

42. Vertical Analysis—Balance Sheet
Liabilities:
Accounts payable $ ,225
Dividends payable 42,741
Income and other taxes payable 68,467
Long-term liabilities 157,127
Other liabilities ,891
Total liabilities $ 489,451
Stockholders’ equity:
Total stockholders’ equity 1,276,197
TOTAL LIAB. & S.E. $1,765,648
5.2%
2.4
3.9
8.9
7.4
27.7%
72.3
100.0%

43. Vertical Analysis—Comparative Balance Sheets
2001
2000
Assets:
Cash and cash equivalents
Short-term investments
Accounts receivable
Inventories
Property, plant, and equipment
Other assets
TOTAL ASSETS
17.4%
19.1%
1.4
13.6
15.8
38.8
13.0
100.0%
1.9
12.2
16.1
38.5
12.3
100.0%

44. Vertical Analysis—Comparative Balance Sheets
2001
2000
Liabilities:
Accounts payable
Dividends payable
Income and other taxes payable
Long-term liabilities
Other liabilities
Total liabilities
Stockholders’ equity:
Total stockholders’ equity
TOTAL LIAB. & S.E.
5.2%
2.4
3.9
8.9
7.4
27.7%
72.3
100.0%
4.6%
2.5
3.9
9.8
7.3
28.1%
71.9
100.0%

45. Vertical Analysis—Income Statement
Net sales $2,429,646
Cost of sales ,054
Gross profit $1,432,592
Selling and administrative exp ,236
Operating income $ 513,356
Other income (expense) ,010
Income before income taxes $ 527,366
Income taxes ,380
Net income $ 362,986
100.0%
41.1
$997,054
$2,429,646

46. Vertical Analysis—Income Statement
Net sales $2,429,646
Cost of sales ,054
Gross profit $1,432,592
Selling and administrative exp ,236
Operating income $ 513,356
Other income (expense) ,010
Income before income taxes $ 527,366
Income taxes ,380
Net income $ 362,986
100.0%
58.9%
$1,432,592
$2,429,646

47. Vertical Analysis—Income Statement
Net sales $2,429,646
Cost of sales ,054
Gross profit $1,432,592
Selling and administrative exp ,236
Operating income $ 513,356
Other income (expense) ,010
Income before income taxes $ 527,366
Income taxes ,380
Net income $ 362,986
100.0%
41.1
58.9%
37.8
21.1%
0.6
21.7%
6.8
14.9%

48. Vertical Analysis—Income Statement
2001
2000
Net sales
Cost of sales
Gross profit
Selling and administrative exp.
Operating income
Other income (expense)
Income before income taxes
Income taxes
Net income
100.0%
100.0%
41.1
42.1
58.9%
37.8
21.1%
0.6
21.7%
6.8
14.9%
57.9%
36.3
21.6%
0.7
22.3%
7.0
15.3%

49. a. Received fees of $6,400 in cash.
Capital
Stock
Cash + Land
Assets
Stockholders’ Equity =
Liabilities +
Notes Payable +
a. 6,400 Revenue 6,400
Retained Earnings
Bal. 5,100 12,000 10,000 6,000 1,100
Bal. 11,500 12,000 10,000 6,000 7,500
Return to income statement

50. b. Paid expenses in cash as follows follows: wages, $1,370; rent, $950; utilities, $540; interest, $100; miscellaneous, $220.
Capital
Stock
Stockholders’ Equity =
Liabilities +
Notes Payable +
Retained Earnings
Assets
Cash + Land
Bal. 11,500 12,000 10,000 6,000 7,500
e. –2,900 Wages expense  –1,370
Rent expense  –950
Utilities expense  –540
Interest expense  –100
Misc. expense  –220
Return to income statement
Bal. 8,320 12,000 10,000 6,000 4,320