CASES Judgment Case 2–1 Requirement 1 Cash basis accounting produces a measure of performance called net operating cash flow. This measure is the difference between cash receipts and cash disbursements during a reporting period from transactions related to providing goods and services to customers. On the other hand, the accrual accounting model measures an entity’s accomplishments (revenues) and resource sacrifices (expenses) during the period, regardless of when cash is received or paid. Requirement 2 In most cases, the accrual accounting model provides a better measure of performance because it attempts to measure the accomplishments and sacrifices that occurred during the year, which may not correspond to cash inflows and outflows. Requirement 3 Adjusting entries, for the most part, are conversions from cash to accrual. Prepayments and accruals occur when cash flow precedes or follows expense or revenue recognition. Judgment Case 2–2 Requirement 1 Cash basis net income Add: 1. Unexpired (prepaid insurance) $12,000 x 8/12 2. Increase in accounts receivable ($6,500 – 5,000) 5. Increase in inventories ($35,000 – 32,000) Deduct: 3. Increase in wages payable ($8,200 – 7,200) 4. Increase in utilities payable ($1,200 – 900) 6. Increase in amount owed to suppliers Accrual basis net income $26,000 8,000 1,500 3,000 (1,000) (300) (4,000) $33,200 Requirement 2 Assets would be higher by $12,500 ($8,000 + 1,500 + 3,000) and liabilities would also be higher by $5,300 ($1,000 + 300 + 4,000). The difference, $7,200, is the difference between cash and accrual income. Therefore, equity would be higher by $7,200. 2– Solutions Manual, Vol.1, Chapter 2 97