Question

On January 1, 2017, Norma Smith and Grant Wood formed a computer sales and service company in Soapsville, Arkansas, by investing \(90,000 cash. The new company, Arkansas Sales and Service, has the following transactions during January.

1. Pays \)6,000 in advance for 3 months’ rent of office, showroom, and repair space.

2. Purchases 40 personal computers at a cost of \(1,500 each, 6 graphics computers at a cost of \)2,500 each, and 25 printers at a cost of \(300 each, paying cash upon delivery

3. Sales, repair, and office employees earn \)12,600 in salaries and wages during January, of which \(3,000 was still payable at the end of January.

4. Sells 30 personal computers at \)2,550 each, 4 graphics computers for \(3,600 each, and 15 printers for \)500 each; \(75,000 is received in cash in January, and \)23,400 is sold on a deferred payment basis.

5. Other operating expenses of \(8,400 are incurred and paid for during January; \)2,000 of incurred expenses are payable at January 31.

Instructions

1. Using the transaction data above, prepare (1) a cash-basis income statement and (2) an accrual-basis income statement for the month of January.
2. Using the transaction data above, prepare (1) a cash-basis balance sheet and (2) an accrual-basis balance sheet as of January 31, 2017.
3. Identify the items in the cash-basis financial statements that make cash-basis accounting inconsistent with the theory underlying the elements of financial statements.

Short answer

(a) Income statement

1. As per cash basis, net loss equals ($31,500).
2. As per accrual basis, net loss equals ($13,900)

(b) Balance sheet

1. As per cash basis, Total assets and total liabilities and equities equals equals $58,500.
2. As per cash basis, Total assets and total liabilities and equities equals equals$108,900

(c) Accounts receivable balance, prepaid rent, accounts payable and salaries and wages payable.

Step-by-step solution

Meaning of Income Statement

The income statement, sometimes referred to as a profit and loss statement, is a document created by a company's management that lists the company's earnings, costs, and net gain or loss for a given period.

(a) Preparing Income Statement

ARKANSAS SALES AND SERVICE Income Statement For the Month Ended January 31, 2017
	Cash Basis	Accrual Basis
Revenues	$75,000	$98,400
Expense
Cost of computers & printers:
Purchase and paid	$82,500
Cost of goods sold		59,000
Salaries and wages	9,600	12,600
Rent	6,000	2,000
Other operating expenses	8,400	10,400
Total expenses	106,500	84,500
Net Income (loss)	$(31,500)	$(13,900)

Working notes:

Calculation of revenues accrual basis

$\begin{array}{rcl}\text{Revenues}& =& \left(\text{Personal}\text{computers}\times \text{Rate}\right)+\left(\text{Graphics}\text{computer}\times \text{Rate}\right)+\left(\text{Printers}\times \text{Rate}\right)\\ & =& \left(30\times \$2,550\right)+\left(4\times \$3,600\right)+\left(15\times \$500\right)\\ & =& \$98,400\\ & & \end{array}$

(b) Preparing Balance Sheet

ARKANSAS SALES AND SERVICE Balance Sheet
	Cash basis	Accrual basis
Assets
Cash	$58,500	$58,500
Accounts receivable		23,400
Inventory		23,000
Prepaid rent		4,000
Total assets	$58,5000	$108,900
Liabilities and owners’ Equity
Salaries and wages payable		$3,000
Accounts payable		2,000
Owners’ capital	$58,500	103,900
Total liabilities and owner’s equity	$58,500	$108,900

Working notes:

Calculation of cash balance

Original investment	$90,000
Cash Sales	75,000
Cash purchase	(82,500)
Rent paid	(6,000)
Salaries paid	(9,600)
Other operating expenses	(8,400)
Cash balance on January 31	$58,500

(c) Identifying and making cash basis inconsistent with the theory underlying the elements of financial statements.

1. The $23,400 in customer receivables represents an asset and unrealized future cash flow from sales. The amount of revenues and asset inflow from the sale of PCs and printers in January is understated by $23,400 on a cash basis.
2. The price of the PCs and printers sold in January is $23,000. Unsold computers and printers represent an inventory asset of $23,000.
3. The cash basis disregards $3,000 of the employees' January pay due to being paid in February.
4. The cash basis overstates rent expenses by $4,000 per month. This prepayment should be recorded as an asset on the balance sheet as a two-month right to use of office, showroom, and maintenance space.
5. The liability for the unpaid portion of these expenses incurred in January is overstated by $2,000 and $2,000 on a cash basis for other operational expenses.