Why is the Accrual Basis of Accounting the preferred method of Financial Reporting for large companies instead of the Cash Basis of Accounting?

Why is the accrual basis of accounting the preferred method of financial reporting for large companies instead of the cash basis of accounting?

First, the accrual basis of accounting provides a more accurate snapshot of the company's current condition. For example, when the company sells its products (as in the transfer of ownership takes place and the company no longer possess the item). If a credit sale has occurred it affects the company financial statement making accrual accounting reflect the economic condition more appropriately than a cash basis accounting.

Furthermore, a company will most likely have accounts payables and accounts receivables. Depending on the company's policies  been on recording the cash/In coming cash flow towards their receivables, the accrual basis  method of accounting reflects things that are not recorded but are anticipated to be received by the company. This method can be extend  into inventory used, real estate purchases, and any other type of transaction that is not immediately finished by the sale.

GAAP does allow for cash basis record keeping, but only if a company starts its bookkeeping that way.

Double Accrued Liability Journal Entry

What would happen if a journal entry that records an accrued liability was accidentally recorded twice on the ledger?


Accounting Question Answer:

Income would be understated for the current accounting period. The error by the accountant makes an expense to be overstated because there is extra debt. At the same time,  the related payable is also overstated on the account because of the extra debit.

In conclusion, when there are double journal entries for an accrued liability, income is understated and liabilities would be overstated on the balance sheet.

See more accounting journal entries.

Section 129 Dependent Care Assistance Exclusion DCAP

What is the § 129 Dependent Care Assistance Exclusion

§ 129 (DCAP) of the internal revenue codes provides an exclusion for “dependent care assistance” received by an employee from his employer, if the employer has a qualifying “dependent care assistance program" in place. There is a $5,000 cap on the employer's DCAP program and the amount that an employee can take advantage of the program.

For corporate cash re-imbursements, the employee must take a pay cut equal to an amount under $5,000 and then submits childcare receipts to his employer. While amounts received as salary would have been taxable, amounts received instead of a cash salary under a DCAP are tax-free. This could save the taxpayer significant sums of money depending on which tax bracket that he is in.

A taxpayer cannot use the same dollars or child care expenses to generate both an exclusion under the Dependent Care Assistance Program and a credit under § 21.

More Specifically, § 129(e)(7) provides that an expenditure used to support an exclusion under § 129 cannot be the basis of a credit under § 21. However, a taxpayer whose employer offers DCAP benefits can choose between the benefits of § 129 and the benefits of § 21 child care credit.

The choice is available for up $5,000 of qualifying expenses.  Because of the higher cap on the § 21 credit, even taxpayers who maximize their § 129 exclusion may claim a $1,000 credit under § 21, assuming that they have at least two qualifying children and at least $6,000 of qualifying expenses.

This exclusion applies only under a specific program that satisfies the specific requirements of requirement.

For additional information, please see IRS Publication 15-B (2012), Employer's Tax Guide to Fringe Benefits

Debt-Equity Ration and Thin Capitalization

What is considered Thin Capitalization?

If a corporation has excessive liabilities in comparison to the capital contributions in its shareholder's equity, the lenders giving loans have a significant risk.  In tax and accounting terms, this means that the corporation is regarded as being thinly capitalized.

The lack of a decent amount of equity increases the riskiness of the debt  investment that lenders made. This factor could be a factor to the IRS when it decides to re-classify the debt as equity. It is important that corporations have a healthy mix of both equity and debt in order to carry on their normal business operations and avoid an IRS audit that might re-classify facially decent debt as equity.

Calculate Beginning Inventory

Accounting Question:

A golf bag company had net purchases of $50,000, an ending inventory of $25,000, net yearly sales of $100,000, and total gross profits of $32,000.

How much was the golf bag company’s beginning inventory for the current year?



Detailed Solution to Accounting Example Problem:

Profit = Sales – COGS (Cost of Goods Sold)

32, 000 = 100,000 - COGS

COGS = 68,000

COGS (Cost of Goods Sold) = Beginning Inventory + Purchases - Ending Inventory

68,000 = Beginning Inventory + 50,000 – 25,000

Correct Answer to Problem:

Beginning Inventory = 43,000

Additional Accounting Tutorials and Accounting Examples:

What are Direct Materials?What are Indirect Materials?

FIFO Method and Weighted Average Inventory Method

Perpetual Inventory System

Basic Equation for Inventory Accounts

Inventory Cost Flow Assumptions

Accounting Inventory Shrinkage Example Problem

Merchandising Accounting Journal Entry

Cost of Capital Bond Debt Example

A company has a bond that has a $ 1000 (face value of bond) and a contract or coupon intrest of 11.5%.

The company's bond has a current market value of $ 1,124 and will mature in 10 years. The company's marginal tax rate is is 34%

What is the cost of capital from this bond debt?

ANSWER:

Cost of Capital for Company = Yield to maturity (YTM) * (1-Marginal Tax Rate)

YTM = (Annual interest+ (Par-Price of Bond )/Number of years until bond maturity )/(Bond par+price)/2

= (115+(1000+1124)/10)/1000+1124/2 =0.0966

Cost of Debt = 0.0966*(1-0.34)=0.063756

Section 61 Taxable Income

All Income is Taxable § 61

Source is always irrelevant under the definition of gross income (§ 61) However, source may become relevant because some other Code section excludes receipts from a particular source from gross income. When a taxpayer is in receipt of an economic benefit, Congress might decide to  exclude that benefit from the taxpayer’s gross income for either two types of reasons:  Because it believes benefits from a particular source should not be taxed, OR; Because it believes a particular type of non-cash benefit should not be taxed.

From an efficiency standpoint (although not fairness standpoint) the best tax is one that does not depend on choices made by the taxpayer; since such a tax is not based on taxpayer behavior, it cannot inefficiently discourage any behavior. Windfall arrives without any effort on taxpayer’s part, so a tax on windfalls is especially attractive from an efficiency view because it does not discourage anything.4 In the absence of any specific inclusion, go back to § 61 and read the rule very broadly. “Treasure Trove” = Income

DEFINITION OF INCOME:

a.    Undeniable Accessions to wealth
b.    Clearly realized
c.    And over which the taxpayers have complete dominion.

Purchase of Vehicle Journal Entry

Accounting Question: If a company purchases vehicles for business, does it include the tax/title charges and the paint jobs for the business logos into the same entry as cost of vehicle?

Example Vehicle Purchase:

Truck 50
Tax/title 10
Alterations of vehicle for business purpose 20


Question: What would be the accounting journal entries for this type of vehicle purchase?




Answer to Vehicle Purchase Accounting Problem:

If the company purchases the vehicle for cash, look at the following accounting journal entries.

DEBIT: Truck - 50
DEBIT: Truck Expense - 30
CREDIT Cash - 80

If the purchase is made on credit would probably be a mix of cash and on account do to the title/taxes. I'm going to put the truck and alterations on account in my example.

DEBIT: Truck - 50
DEBIT: Truck Expense - 30
CREDIT Cash - 10
CREDIT: Accounts Payable - 70