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Finance and capital markets
Course: Finance and capital markets > Unit 5
Lesson 1: Cash versus accrual accountingCash accounting
Simple example of cash accounting. Created by Sal Khan.
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If raw materials and work in process inventories had decreased during the year, would the financial statements be different? How?(5 votes)
Yes, the financial statements would be different. I'm assuming that your question relates to a manufacturing company complying with the accrual basis of accounting. Such a company usually has an asset account on its balance sheet called Inventories which has three components: Raw Materials, Work In Process (WIP) and Finished Goods. Generally, when Raw Materials Inventory decreases (such as when materials are used to produce a product), then Work In Process Inventory (WIP) would increase. When WIP decreases (such as when the product manufacturing process is complete), then Finished Goods Inventory would increase. Finally, when Finished Goods Inventory decreases (such as when the product is sold), Cost of Goods Sold (an expense on the income statement) would increase. Accordingly, the sale of product would also be recorded by increasing Accounts Receivable or Cash, and increasing Sales (a revenue source on the income statement). Hope that helps!(19 votes)
- how to create a balance sheet?(13 votes)
To create a balance sheet you need to use the accounting equation: Assets = Liabilites + Equity
On the Assets side you would list anything that is, of course, an asset. Assets are defined as anything that is expected to provide future benefit for the company or anything that the company owns, i.e. cash, property and equipment, land, etc.
On the Liabilities + Equity side, you would list your expenses (wage expenses, dividends, utilities, etc.) and your equity (retained earnings, stock)
After you add the total for both sides, they should balance out.(2 votes)
- At "2:17", how can you have negative profit? The table should say "Profit/Loss". When your expenses exceed your revenue you are left with a loss of $200. Then when you balance that against your Assets (cash) you see your total Cash balance.(1 vote)
- In cash accounting, a "negative profit" is really deferred profit. It is not a loss or an expense. I hope this helps. Further videos in accounting will explain it further . . .(12 votes)
- what is straight line amortization?(2 votes)
- Using straight-line amortization, you would calculate the annual amortization amount by using this formula:Total Cost/# Years in the Amortization Period = Annual amortization amount.
For example, a loan of $20,000 is amortized over a period of 5 years using straight line amortization. The annual amortization amount would be: $20,000/5 = $4,000 per year.
Straight-line amortization results in equal amounts of annual amortization of the loan.(7 votes)
- If a company pays a bill on Oct 31 when is it recorded.(2 votes)
Under the Cash Accounting method, you would record the bill as an expense for the month of October.(1 vote)
- Im so confused of how we got -100$? Can someone please help(2 votes)
- Wait for the cash accounting video, and for month 2, if we put profit as -200 or just 0, that would be the same thing?? Also, wouldn't the cash amount not be -100, but -200 too for month 2? lol(2 votes)
This is a balance sheet right?(2 votes)- no it's just like a cash account prepared on monthly basis.(1 vote)
I notice that the Final, or the Accrual Profit in Cash - $400 - is equal to the sum of the Profits of all 4 months surveyed - $100 - $200 + $600 - $100. Is it the difference between Cash Accounting and Accrual Accounting: the former concentrates on every month in particular, while the latter concerns only the final outcome of the whole period ?(1 vote)
No, cash accounting just says whatever cash went in and out that month determines the profit. If you bought a $50,000 truck that will last for 10 years, cash accounting says you had a $50,000 expense that month. Then in other months when you use the truck to make money it will look like you are extra profitable because you didn't have to buy a truck that month.
Accrual accounting smoothes that out by recognizing, for example, that the expense of the truck ought to be spread out over time in order to more accurately reflect the profitability of the business.(3 votes)
- I record my expenses and incomes in cash accounting and find it not matching the actual situations. For example I pay for internet in advance of the service offered. I pay for phone bill after the month being charged. How can I switch to accrual basis so that the expenses and incomes that belong to a certain month can be calculated in that month? How can I start doing accrual accounting before I get my bills?(1 vote)
- Any expenses paid for in advance would become prepaid expenses (an asset on the balance sheet). For example: $100 internet charge paid in advance:
- Balance sheet: cash decreases by $100, prepaid expenses increase by $100
- Then once the internet service is provided, prepaid expenses would decrease by $100 and would be recognized as an expense on the income statement.
Any expenses that are paid after you use the service would become accrued expenses (a liability on the balance sheet). For example: $100 phone bill that is paid a month after using the service.
- When the service is used, a $100 expense is recognized on the income statement and a $100 accrued expense on the balance sheet.
- When the expense is paid out in cash, cash and the accrued expense would both decrease by $100 on the balance sheet.
These are simplified explanations that don't take into account things like the cash flow statement. But, it is difficult to write these things out in words. Much easier to draw them.(2 votes)
2:17Video transcript
To see the difference between
cash accounting and accrual accounting, I'm going to go
through this little example. And first I'm going
to account for things using a cash basis
of accounting. And then we'll do it
with an accrual basis. And just so you
have some context, the cash basis is any time
you get cash from a customer, you would count that as revenue. And any time you
have to spend cash, you count that as an expense. And you'll see that that's
what most small businesses do, while most slightly more
sophisticated businesses would use accrual-based accounting,
because that matches up your actual expenses and your
revenue a little bit better in each period. So let's just go
through this example, using the cash basis first. And we're going to assume that
we start off with no money. So in Month 1, you cater an
event where the cost to you was $100. The customer pays you
$200 for your services. And maybe they pay your
$200 ahead of time, so that you have the cash to go
buy the food and the paper cups and paper plates or whatever. So you get $200 in revenue. This is a cash
basis of accounting. And you get to spend
$100 of that on supplies, and maybe you had
to hire some help, and you had to pay
yourself a salary. So if you got $200, and
you used $100 of that, your profit here-- I'll
do profit in green -- your profit is going to
be-- no, that's not green-- your profit is going to be $100. And if you started
with no cash, your cash at the end of
period-- this is going to be the cash at
the end of Month 1-- you will now have $100 of cash. Now let's go to Month 2. You cater an event where
the cost to you was $200. You and the customer
agree that they can pay you $400 the next month. So in this month,
we have to use $200, maybe our bank
lets us overdraft, so let's say-- I shouldn't
write-- This is an expense, so I don't have
to write negative, we're assuming this is going
out, I'll write it in red. So we are going to use $200,
but we don't get any revenue because we're doing the
cash basis accounting. The customer's not
paying us in that month. They're paying us
$400 the next month. So we get no revenue
in that period. So it looks like
we got no revenue. We had $200 of expenses. Our profit here is going
to be negative $200. And when we look
at how much cash, we had $100 of cash
entering into Month 2. We're using $200 of that. And so now we've kind of
overdrawn our bank balance. Maybe we owe our bank now $100. Let's go to Month 2. You get $400 from the customer
in the previous month. You also get $200 in
advance from a customer that you have to
cater for next month. So we've done no
catering this month, but we've got a lot of money. We got $400 from the
previous month's customer and $200 for a
customer that you're going to cater for next month. So we got $600 on the
cash basis in revenue. And we had no expenses
in that month. So we have $600 in profit,
and our cash balance increases by $600. So at the end of this
month, we now have $500. Now Month 4, you cater
the last customer's event. It cost you $100. So once again, you
just have to spend-- I want to do that in
magenta-- you just have to spend the $100 in Month
4 to cater the actual event, but you got no
revenue in that month. So it looks like you took
a loss, negative $100. And then your cash balance
will go down to $400. So this is a cash basis. This is how a lot of
businesses run it. But as you can see,
there's a problem here. It looks like our profit is
jumping all over the place. Sometimes we're profitable,
sometimes we're not. Sometimes we're profitable,
sometimes we're not. Even though our business is a
little bit steadier than that would seem to imply.