ASSIGNMENT | Cash Basis of Accounting

During a specific accounting period, a hospital has earned $1,500,000 in revenues and consumed $600,000 in resources. Consider the following three scenarios. In scenarios A and B, cash basis of accounting method is followed. In scenario C, accrual basis of accounting rules are followed.
Scenario A – management wants the financial statements to show high profit, it delays paying the bills until after the accounting period, although full payment of $1,500,000 is collected.
Scenario B – management wants the financial statements to show low profit, maybe in order to encourage donations. It discourages patients and third-party payors from paying until after the accounting period. All the bills, $600,000, get paid on time.
Scenario C – according to accrual basis of accounting method, the financial statements report revenues, $1,500,000, when revenues are earned; and expenses expended to generate those revenues of $600,000, when resources are used.

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Reported records
Scenario A
Scenario B
Scenario C
Revenues
$1,500,000
$0
$1,500,000
Expenses
$0
$600,000
$600,000
Profit
$1,500,000
($600,000)
$900,000

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Discuss how the cash basis of accounting is vulnerable to management’s manipulation and how the accrual basis of accounting overcomes the disadvantages of the cash basis of accounting.
When looking at a capital investment into a project for an organization, management needs the board’s approval for the funds. Because of this need for approval, there is sometimes a tendency to overstate revenue and understate expenses associated with the project. Why do you feel that management would overstate revenue and understate expenses? What are the consequences of doing this?

SAMPLE SOLUTION

Cash Basis of Accounting
Cash-basis accounting is a major accounting method that primarily focus on cash inflows and outflows. This implies that cash basis method allows organizations to record cash transactions for expenses and revenue only when the corresponding payments are made or cash is received. The use of this method is limited under GAAP or IFRS since it can lead to inaccurate results, unfair presentation of financial statements, and non-disclosure of non-financial activities (Ginter, Duncan & Swayne, 2018). GAAP do not…