Explain Why the Income Statement is Prepared Using the Accrual Basis of Accounting and How This Differs from Cash Accounting

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Explain what a credit sale is in a business context.

 

SKU: ACC202671

Preparation of Report

Babs Lee is a good friend who is surprised to learn that her Uncle has died and left her a wholesale business which sells ukuleles to music shops throughout New Zealand. The business is called Isaleh. The executor of the will, R. Senior, has provided Babs with the latest financial statements (Appendix A) and she brings these to you as she knows you have started studying accounting at Massey University.

Babs thinks it might be fun to run the business for a while but she has no idea how sensible that would be. Babs is puzzled as to why there is an Income Statement as well as a Cash Flow Statement. “Surely” she says “income is cash coming into the business and expenses are cash going out of the business. If so, why have they provided two statements and I can‘t see what one has got to do with the other. The figures don’t match up.”

Babs has heard of a Balance Sheet and she can see that this one balances. However, in the middle in bold are the words “Working Capital” and she has no idea what this relates to. “If anyone is going to be working” she says, “it will be the two assistants and me”.

An attached note says that 60% of the sales are on credit with terms that the invoice should be paid by the 20 th of the following month. “Does that mean a credit card or what?” Babs asks.

Required:

Prepare a report for Babs Lee:

a) Explain why the Income Statement is prepared using the accrual basis of accounting and how this differs from cash accounting.

b) Explain what Working Capital is and why it is important to manage it.

c) Explain what a credit sale is in a business context. Give reasons as to why a business sells goods on credit and the costs which are associated with doing so.

Separate marks are awarded for:

  • Presentation of Report.
  • Conclusions and recommendations.

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