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Judgment Case 2-1 (page
109)
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.”
Required:
1. Explain the difference between a cash basis
and an accrual basis measure of performance.
2.
Why, in most cases, does accrual basis net income provide a better measure
of performance than net operating cash flow?
3. Explain the purpose of adjusting entries as
they relate to the difference between cash and accrual accounting.
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