You have recently been hired by Davis & Company, a small public accounting firm. One of the firm’s partners, Alice Davis, has asked you to deal with a disgruntled client, Mr. Sean Pitt, owner of the city’s largest hardware store. Mr. Pitt is applying to a local bank for a substantial loan to remodel his store. The bank requires accrual based financial statements but Mr. Pitt has always kept the company’s records on a cash basis. He does not see the purpose of accrual based statements. His most recent outburst went something like this: “After all, I collect cash from customers, pay my bills in cash, and I am going to pay the bank loan with cash. And, I already show my building and equipment as assets and depreciate them. I just don’t understand the problem.Mr. Pitt has relented and agrees to provide you with the information necessary to convert his cash basis financial statements to accrual basis statements. He provides you with the following transaction information for the fiscal year ending December 31, 2016: 1. A comprehensive insurance policy requires a payment every year for the upcoming year. The last payment of $12,000 was made on September 1, 2016. 2. Mr. Pitt allows customers to pay using a credit card. At the end of the current year, various credit card companies owed Mr. Pitt $6,500. At the end of last year, customer credit card charges outstanding were $5,000. 3. Employees are paid once a month, on the 10th of the month following the work period. Cash disbursements to employees were $8,200 and $7,200 for January 10, 2017, and January 10, 2016, respectively. 4. Utility bills outstanding totaled $1,200 at the end of 2016 and $900 at the end of 2015. 5. A physical count of inventory is always taken at the end of the fiscal year. The merchandise on hand at the end of 2016 cost $35,000. At the end of 2015, inventory on hand cost $32,000. 6. At the end of 2015, Mr. Pitt did not have any bills outstanding to suppliers of merchandise. However, at the end of 2016, he owed suppliers $4,000. Required: 1. Mr. Pitt’s 2016 cash basis net income (including depreciation expense) is $26,000. Determine net income applying the accrual accounting model. 2. Explain the effect on Mr. Pitt’s balance sheet of converting from cash to accrual. That is, would assets, liabilities, and owner’s equity be higher or lower and by what amounts?
You have recently been hired by Davis & Company, a small public accounting firm. One of the firm’s partners, Alice Davis, has asked you to deal with a disgruntled client, Mr. Sean Pitt, owner of the city’s largest hardware store. Mr. Pitt is applying to a local bank for a substantial loan to remodel his store. The bank requires accrual based financial statements but Mr. Pitt has always kept the company’s records on a cash basis. He does not see the purpose of accrual based statements. His most recent outburst went something like this: “After all, I collect cash from customers, pay my bills in cash, and I am going to pay the bank loan with cash. And, I already show my building and equipment as assets and
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