Accrual Basis Accounting

What Is Accrual Basis Accounting?
As the meaning of the word "accrual", natural growth or increase, accrual basis accounting has four crucial parts, which are time, recognition, liabilities, and allocation. Accrual basis accounting is the better choice of accounting methods, it reflects the truthful and complete business activities. 

Time
Not every transactions and event are both inflows and outflows at the same time, just like the time you use your credit card, you don't have outflows of cash at that moment, but have liability to pay the bill a few days later. By the time you made the payment, you are already in the next consumption period. The insurance company does not complete its obligation unit the contract expires. 

Recognition
Since accrual accounting is reflective of measuring revenues as earned and expenses as incurred, both of the two conditions, which are exchange transaction and earning process is completed, must be met, even though, you have got the cash in advance or provided services ahead of inflow of cash.

Liabilities
Similar to the notion of debit and credit rules, after you get the cash, you have the obligation to offer your products or services, that's one of the core concepts of accrual basis accounting. You don't just simply earn the money after you sold an insurance contract, instead, you have the obligation to take the risk for the client.

Allocate
Instead of just picking up the dates of inflows and events, to reflect the activities, some expenses and revenues are allocated to different periods. Because the inflows of cash do not actually mean the process is done and you don't have any obligation to provide outflows of anything. 

What Is Cash Basis Accounting? 
Just like the term "cash basis", the records are focus on the inflows and outflows of cash, transactions, and events. Revenues are confirmed while cash is flow in, whatever it does match the rule of sold, delivered or earning process being complete or not, and it does not allocate to different periods or reports. 

What's The Difference?
1.Allocate or not
To reflect the more detailed activities, some expenses and revenues need to be separated to different periods and shown on multiple reports.

2. Recognition rules
Accrual basis accounting has its own rules to recognize expenses and revenues in different periods. This is the preview rules for deciding how allocates are being set on procedures, considering not every event should be allocated.

3. Reflect obligations or not
Every business income does not just grow on trees, It involved the obligations to provide or offer something, besides, you deserve some benefits after you provide goods or services. When you sold a car with a 3-month contract, you have the obligation to provide what you needed to offer, not only confirm the inflows of revenues, but also the liabilities of the contract, although it may occur at different time points.

4. Collecting periods.
After recognizing revenues and expenses, you must collect the data of different periods to allocate it. Prepaid insurance has the right for 3 months, so it allocated to 3 months. 

Why Not Just Use Cash Basis?
This is a question that being frequently asked. Why not just use our chequebook records? If we take a closer look at the financial reports, we shall find out that the cash basis accounting is not a well-balanced choice. Assets = Liabilities + Equity. It's a "balance" of both two sides, not just look at how much inflows you made in any particular periods. The income must come from somewhere, and the outflows must have its reasons to go anywhere. 

To compare the difference, just look at your credit card bills and record your payments. You will soon find that you may have a $1,000 outflow to the bank, but rarely outflows of the others. When you purchasing something, you don't have any outflows of cash, if you forget to record your liabilities to pay it later.

Where you live and describe how the financial statements of that company would be useful to the business leaders of that company and to outside investors

Introduction

My father runs a food company in Taiwan since 2005. He frequently faces some tough choices and some of it was living or dead, thus he needs financial statements to support his decisions. Although those decisions not always end up with good results, but still reduce the chance to fall like gambling. The statement of cash flows reflects his company's daily operations and shows how the cash flows in and out. The balance sheet shows how healthy his company is in finance, how much resources he can use in the future and how many liabilities he has. The income statement shows the efficiency of his company in making profits and he can know which part is the most important one, the largest part of the total revenues. Despite, he owns the company with no shareholders, no report on the owner's equity, pay attention to the information of it is a preparation for the future.

Statement of Cash Flows

This report shows the operating of his company and reveals how cash is generated and expended during a specific period of time, a month or a year. The cash inflows and outflows may attributable to operating activities, investing activities, and financing activities. For instance, his factory needs to purchase pork as an ingredient in making several products, this activity cause outflows of cash. He can understand how much pork he has purchased in operating by reviewing the report. How does this helpful? Well, if he trying to make a decision such as limit his cost on production or budgeting his cost on production, although it is a record of the history. Another crucial part of the statement of cash flows is that it provides a standard, accurate and impartial of these operating activities. 

The Income Statement

As we have learned about the income statement, every business owners desire to know how much revenues they earn from their customers, either does my father. The income statement shows how much inflows from customers, the cost of production and the net income, my dad can make his decision accordingly, such as how attractive his products are. For instance, if he increases the prices of his products, opening a sale project, or putting on an advertisement, he wants to know how much of these costs affect his revenues. Suppose my father wants to gain more capital to expand his business, this is the information that outside investors would like to see. 

The Balance Sheet

Just like every time we decided to go outdoor with umbrella or not. Did you make the decisions without watching the weather forecast? Or you just bet you are lucky and everything is under your control? That's why we need financial statements to support our decisions. On the balance sheet, we shall know how much resources we have, how much liabilities, and what's the equity. It is crucial to know how much abilities you have if you are making a life-or-death decision. Overestimate yourself can end up with the cost of your lifetime earning. Business owners can use the retained earnings to purchase more equipment or just keep it for the expected upcoming winter. 

The accounting equation and its key component.

The accounting equation and its key component.

According to the principle of accounting, the fundamental accounting equation is : 

Assets = Liabilities + Owners’ Equity

Assets are basically the economic resources owned by the entity, such as cash, accounts receivable, inventories, land, buildings, equipment, and even intangible assets like patents and other legal rights. 

Liabilities, in short, are obligations and duty, which are amounts owed to others. Loans, extensions of credit. It's basically the existing obligation to pay or perform some duty.

Owners’ equity also called net assets since it is equivalent to assets minus liabilities, and depends on the legal form of the entity, the owner is different. For instance, a business can run by sole proprietorships, partnerships, and corporations. A sole proprietorship is a business owned by one person and typically consists of a single owner’s capital account. A partnership is a business owned by more than one person, with a separate capital account for each partner. A corporation is ownership interest being represented by divisible shares of stock, generally corresponding to the owner investments in the capital stock and additional amounts generated through earnings that have not been paid out to shareholders as dividends. 

Generally accepted accounting principles

According to the principle of accounting, financial reports prepared under the generally accepted accounting principles (GAAP), intended to be general-purpose, not prepared especially for owners, or creditors, or any other particular user group. Instead, they are intended to be equally useful for all user groups. As such, attempts are made to keep them free from bias (neutral). Standard-setting bodies are guided by concepts that are aimed at production of relevant and representationally faithful reports

Key principles

1. Not prepared especially for owners, or creditors, or any other particular user group.
2. Equally useful for all user groups
3. Keep free from bias and neutral
4. Relevant and representationally faithful

The basic financial statements and their purpose

As we have learned from the textbook, the income statement, statement of retained earnings, statement of cash flows and balance sheet are the four core financial statements. 

The income statement, a summary of an entity’s results of operation for a specified period, in short, is operations, revenues, and expenses, partly similar to our daily life(We get paychecks and we spend it). 

Statement of retained earnings provide dividends, net income or loss information. 

The balance sheet is an overall summary of total assets, liabilities, and equity. The balance sheet portrays financial position while other statements reflect the results of operations.

Statement Of Cash Flows provide the details of an entity's cash flows, in other words, why we spend, received and how much the amounts of these flows.

#Learning Journal #Economy Activities

Suppose a construction company is trying to decide whether to buy a new nail gun. The table below shows the hypothetical costs for the nail gun and the amount the gun will save the company each year. Assume the gun will last forever. In each case, determine the highest interest rate the company should pay for a loan that makes the purchase of the nail gun possible.

a. The $1,000 cost of the new nail gun in the example given affects a decision to purchase it. We saw that buying the new nail gun makes sense at interest rates below 10% and does not make sense at interest rates above 10%. If the new nail gun costs $1,000, then the interest return on the investment would be 10% (the annual saving of $100 divided by the $1,000 initial cost), and the investment would be undertaken at any interest rate below 10%.

b. Buying the new nail gun makes sense at interest rates below 20% and does not make sense at interest rates above 20%. If the new nail gun costs $1,000, then the interest return on the investment would be 20% (the annual saving of $200 divided by the $1,000 initial cost), and the investment would be undertaken at any interest rate below 20%.

c. If the new nail gun costs $1,000, then the interest return on the investment would be 30% (the annual saving of $300 divided by the $1,000 initial cost), and the investment would be undertaken at any interest rate below 30%.

A car company currently has a capital stock of $100 million and desires a capital stock of $110 million. 

1. If it experiences no depreciation, how much will it need to invest to get to its desired level of capital stock?

To get to its desired level of the capital stock of $110million, with no depreciation, it needs to invest an additional $10 million

$110 - $100 + 0 = $10

2. If its annual depreciation is 5%, how much will it need to invest to get to its desired level?

To get to its desired level of the capital stock of $110million, with 5% of depreciation, it needs to invest an additional $15 million

$110 - $100 + $100*5% = $15

3. If its annual depreciation is 10%, how much will it need to invest to get to its desired level?

To get to its desired level of the capital stock of $110million, with 10% depreciation, it needs to invest an additional $20 million

$110 - $100 + $100*10% = $20

Burger World is contemplating installing an automated ordering system. The ordering system will allow Burger World to permanently replace five employees for an annual (and permanent) cost savings of $100,000.

1. If the automated system costs $1,000,000, what is the rate of return on the investment?

The rate of return on the investment is 10% ( $100,000 / $1,000,000 ), since the automated ordering system will replace five employees for an annual (and permanent) cost savings of $100,000.

2. If the system cost $2,000,000, what would be its rate of return?

The rate of return on the investment is 5% ( $100,000 / $2,000,000 ), if the automated ordering system will replace five employees for an annual (and permanent) cost savings of $100,000.

3. If the government were to introduce an investment tax credit that allows firms to deduct 10% of its investment from its tax liability, what would happen to the rate of return if the system costs $1,000,000?

If an investment tax credit that allows firms to deduct 10% of its investment from its tax liability, then the return on investment will increase by 10%. 

$1,000,000*10% = $100,000 (Return on deduct 10% of its investment from its tax liability)

$100,000 + $100,000 = $200,000 (Total return on investment)

 ( $200,000 / $1,000,000 ) = 20%

The rate of return on the investment might be 20%

4. If Burger World has to pay 8% to borrow the funds to purchase the system, what is the most it should pay for the system? Assume that there is no investment tax credit.

Suppose the system costs $1,000,000 and Burger World has to pay 8% to borrow the funds to purchase the system and the ordering system will allow Burger World to permanently replace five employees for an annual (and permanent) cost savings of $100,000.

The funds which Burger World has to pay to borrow the funds to purchase the system is $1,000,000*8% = $80,000

Since the ordering system will allow Burger World to permanently replace five employees for an annual (and permanent) cost savings of $100,000

The most it should pay for the system should below the profitable line of $100,000

Look up the table on Federal Receipts and Outlays, by Major Category, in the most recent Economic Report of the President available in your library or on the Internet.

Look up the table on Federal Receipts and Outlays, by Major Category, in the most recent Economic Report of the President available in your library or on the Internet.

1. Complete the following table: 

Sources: Department of the Treasury and Office of Management and Budget

[Billions of dollars; fiscal years]

Category.                                              Total outlays               Percentage of total outlays

National defense.                                  737.9                            15.5%

International affairs                               53.1                              1.1%

Health                                                       616.0                               13%

Medicare                                                  685.2                            14.4%

Income security                                     514.2                               11%          

Social Security                                     1,107.1                            23.3%

Net interest.                                            478.8                              10%

Other                                                         553.2                            11.7%

-------------------------------------------------------------------------------------------------------------------------------

Total                                                       4745.6                               100%

2. Construct a pie chart showing the percentages of spending for each category in the total.

Add caption

Suppose a country has a national debt of $5,000 billion, a GDP of $10,000 billion, and a budget deficit of $100 billion.

1. How much will its new national debt be? 

The new national debt = national debt of $5,000 billion + the budget deficit of $100 billion

So, the new national debt will be $5,100 billion ($5,000 + $100 = $5,100)

2. Compute its debt-GDP ratio.

Its debt-GDP ratio is  $5,100 billion /  $10,000 billion = 51%

3. Suppose its GDP grows by 1% in the next year and the budget deficit is again $100 billion. Compute its new level of the national debt and its new debt-GDP ratio.

Since the budget deficit is again $100 billion, and the new national debt equals the national debt plus the budget deficit.

So, next year, the new level of national debt will be $5,100 billion + $100 billion = $5,200 billion 

Because the GDP grows by 1% in the next year, the new GDP will be $10,100 billion ( 10,000*(100%+1%) )

The new debt-GDP ratio will be $5,200 billion / $10,100 billion = 51.5% (51.48%)

Suppose a country’s debt rises by 10% and its GDP rises by 12%.

1. What happens to the debt-GDP ratio?

Suppose the national debt = D, GDP = P

The debt-GDP ratio = the national debt / GDP = D/P

If the debt rises by 10% and GDP rises by 12%, then

The new debt-GDP ratio = 110%D/112%P = (110%/112%)*(D/P) = 0.98*(D/P) = 98%(D/P)

The new debt-GDP ratio is 2% lower than the former ratio.

That means the ratio of the debt-GDP is decreasing and the government surplus, and likely due to inflation.

2. Does the relative level of the initial values affect your answer?

Suppose that the debt rises by 10% and GDP rises by 10%, then the new debt-GDP ratio will be the same as the initial ratio. 

110%D/110%P = (110%/110%)*(D/P) = 1*(D/P) 

Suppose that the debt rises by 5% and GDP rises by 10%, then the new debt-GDP ratio will be lower than the initial ratio. 

110%D/110%P = (105%/110%)*(D/P) = 0.95*(D/P) = 95%(D/P)

Suppose that the debt rises by 10% and GDP rises by 5%, then the new debt-GDP ratio will be higher than the initial ratio. 

110%D/110%P = (110%/105%)*(D/P) = 1.05*(D/P) = 105%(D/P)

So, the relative level of the initial values is likely to change the answer.

The Fed uses many tools to influence economic conditions but their three most common include: 1. Open-Market Operations (OMOs) - the purchase and sale of U.S. government securities. 2. Reserve Requirements (RR): affects how much money banks can create by making loans. 3. The Discount Rate - The interest rate on loans the Fed makes to banks.

Here are annual values for M2 and for nominal GDP (all figures are in billions of dollars) for the mid-1990s.

 Year          M2        Nominal GDP

1993     3,482.0         $6,657.4

1994     3,498.1         $7,072.2

1995     3,642.1         $7,397.7

1996.    3,820.5         $7,816.9

1997     4,034.1         $8,304.3

1. Compute the velocity for each year.

According to the equation of exchange in the textbook, the relationship between money supply, velocity, and nominal GDP can express like the equation below:

 Suppose that the M=money supply=M2, V=velocity, then

MV = nominal GDP

V = (nominal GDP)/M 

So, the velocity each year on the list will be:

Year.                   Velocity

1993                    6,657.4/3,482.0 = 1.912

1994.                  7,072.2/3,498.1 = 2.022

1995                   7,397.7/3,642.1 = 2.031

1996                   7,816.9/3,820.5 = 2.046

1997                   8,304.3/4,034.1 = 2.059

2. Compute the fraction of nominal GDP that was being held as money.

According to the textbook, the equation of exchange can express the demand for money as a percentage, given by 1/V, of nominal GDP. With a velocity of V, for example, people wish to hold a quantity of money equal to 1/V of nominal GDP.

So, the velocity each year on the list will be:

Year.                   Being Held

1993                    (6,657.4)*(1/1.912)=3481.90

1994.                   (7,072.2)*(1/2.022)=3497.63

1995                    (7,397.7)*(1/2.031)=3642.39

1996                    (7,816.9)*(1/2.046)=3820.58

1997                    (8,304.3)*(1/2.059)=4033.17

3. What is your conclusion about the stability of velocity in this five-year period?

In this case, during the five-year period, the stability of velocity might due to the stability of the interest rate. People do not like to hold something that expected to lose their value. The interest rate will affect the extra money that people can earn from deposit it more. The reason for the stability of velocity is likely to be a stability of interest rate policy.

Another reason for this case is possibly the expectation of stability. The expectation of deflation or inflation will affect the money people want to hold, they can turn their money back really fast these days. 

Here are annual values for M2 and for nominal GDP (all figures are in billions of dollars) for the mid-2000s.

Year.        M2                Nominal GDP

2003        6,055.5                $10,960.8

2004        6,400.7                $11,685.9

2005        6,659.7                $12,421.9

2006        7,012.3                $13,178.4

2007        7,404.3                $13,807.5

1. Compute the velocity for each year.

Suppose that the M=money supply=M2, V=velocity, then

MV = nominal GDP

V = (nominal GDP)/M 

So, the velocity each year on the list will be:

Year.                           Velocity

2003                            10,960.8/6,055.5 = 1.810

2004.                           11,685.9/6,400.7 = 1.826

2005                            12,421.9/6,659.7 = 1.865

2006                            13,178.4/7,012.3 = 1.879

2007                            13,807.5/7,404.3 = 1.864

2. Compute the fraction of nominal GDP that was being held as money.

Year.                      Being Held

2003                       (10,960.8)*(1/1.810)=6055.69

2004.                      (11,685.9)*(1/1.826)=6399.73

2005                       (12,421.9)*(1/1.865)=6660.54

2006                       (13,178.4)*(1/1.879)=7013.51

2007                       (13,807.5)*(1/1.864)=7407.45

3. What is your conclusion about the stability of velocity in this five-year period?

In this five-year period, people hold more and more money. And in the short run, it is not reasonable to assume that velocity and output are constants. Due to the expectations of the interest rate, people adjust their holding to react to the condition. In this case, people are likely to expect that there are some reasons for them to increase their holdings.

Suppose the velocity of money is constant and potential output grows by 3% per year. By what percentage should the money supply grow in order to achieve the following inflation rate targets?

Suppose that :

%ΔM = the percentage rates of change in the money supply

%ΔP = the percentage rates of change in the price level

%ΔYp = the percentage rates of change in the real GDP(potential output)

%ΔM ≌ %ΔP + %ΔYp

%ΔP ≌ %ΔM - %ΔYp

If the velocity of money is constant and potential output grows by 3% per year

1. 0% 

If the rate of inflation, %ΔP = 0% is our target, then

%0 ≌ %ΔM - 3%

%ΔM = 3%

The money supply should grow 3%, in order to achieve the inflation rate targets 0%

2. 1% 

If the rate of inflation, %ΔP = 1% is our target, then

%1 ≌ %ΔM - 1%

%ΔM = 2%

The money supply should grow 2%, in order to achieve the inflation rate targets 1%

3. 2%

If the rate of inflation, %ΔP = 2% is our target, then

%2 ≌ %ΔM - 2%

%ΔM = 4%

The money supply should grow 4%, in order to achieve the inflation rate targets 2%

About Marginal Propensity to Consume and the Multiplier

What is the marginal propensity to consume when consumption changes from 7 to 6 and disposable income changes from 5 to 3?

According to the material, the ratio of the change in consumption (ΔC) to the change in disposable personal income (ΔYd) is the marginal propensity to consume (MPC). The Greek letter delta (Δ) is used to denote “change in.”

The marginal propensity to consume (MPC)=(ΔC)/(ΔYd)

The change in consumption (ΔC) is from 7 to 6, so the change is -1 (If we focus on the "change", not the direction of positive or negative, that answer is 1)

The change in disposable personal income (ΔYd) is from 5 to 3, the change is -2 (If we focus on the "change", not the direction of positive or negative, that answer is 2)

The marginal propensity to consume (MPC)=(ΔC)/(ΔYd)=(-1)/(-2)=0.5

If disposable personal income is 10 and consumption is 12, what is personal savings? 

According to the material, personal saving is disposable personal income not spent on consumption during a particular period. ( Personal saving = disposable personal income - consumption )

If disposable personal income is 10 and consumption is 12, then the personal saving will be 10 minus 12, that equals minus 2 (10-12=-2)

What does this mean?

In this case, the consumption exceeds disposable personal income, so we get a negative value for saving and the excess must have come from saving accumulated in the past, from selling assets that earned in the past, or even from borrowing.

It also means that consumption choices could be affected by expectations of income and almost all consumption choices could be affected by it over a very long period. 

What is the multiplier when the change in the equilibrium level of real GDP in the aggregate expenditures model is 9, and change in autonomous aggregate expenditures is 3?

Suppose that :

ΔYeq = The change in the equilibrium level of real GDP

ΔA ̄ = The change in autonomous aggregate expenditures

MPC = marginal propensity to consume 

MPS = marginal propensity to save

And, the multiplier is the number by which we multiply an initial change in aggregate demand to get the full amount of the shift in the aggregate demand curve. 

So, the multiplier = ΔYeq/ΔA ̄ 

The relationship between a change in autonomous aggregate expenditures and the change in the equilibrium level of real GDP.

The multiplier = ΔYeq/ΔA ̄ = 9/3 = 3

According to the material, a change in autonomous aggregate expenditures changes equilibrium real GDP by a multiple of the change in autonomous aggregate expenditures. The size of the multiplier depends on the slope of the aggregate expenditures curve. The steeper the aggregate expenditures curve, the larger the multiplier; the flatter the aggregate expenditures curve, the smaller the multiplier.

What is the multiplier when the marginal propensity to save is 1/3?

The multiplier = ΔYeq/ΔA ̄ = 1/(1-MPC) = 1/MPS = 1/(1/3) = 3

What would happen to the marginal propensity to save when a tax cut was enacted causing the multiplier to change to 5?

Suppose that :

MPS = marginal propensity to save

MPC = marginal propensity to consume

If the multiplier = ΔYeq/ΔA ̄ = 1/(1-MPC) = 1/MPS = 5

then, MPS = 1/5 = 0.2 

Reference

https://my.uopeople.edu/pluginfile.php/588647/mod_resource/content/1/TEXT%20macroeconomics-principles-v2.0.pdf

#Learning Journal “The Business Cycle

When I was a little boy, my father runs a key and locker manufactury factory. It was all so great during my childhood. It seems like all kinds of toys, foods, entertainment I don't need to be just wanted. But that kind of living ends in 1997.

It's the Asian financial crisis. 

While Thailand announced the abandonment of the fixed exchange rate system and the implementation of a floating exchange rate system. The exchange rate of the Thai baht to the US dollar plummeted by 17%, causing other financial markets to become chaos. Under the influence of the fluctuation of the Thai baht, the Philippine peso, the Indonesian rupiah and the Malaysian ringgit have successively become the targets of international speculators. Taiwan suddenly abandoned the Taiwan dollar exchange rate, depreciating 3.46% a day. The South Korean government sought help from the International Monetary Fund to temporarily control the crisis. The crisis also hit the Japanese financial industry, which has invested heavily in South Korea. A series of Japanese banks and securities companies went bankrupt. 

An Economic Trough

During that period, my father has to downsize the business and cut down on the number of staff. And it's not only my father's business got influenced but also the entire country or even Asia got chaos. The unemployment seems to be out of control and the government did not use their monetary policy tools well. The financial crisis had dramatic and immediate effects on the economy. I think it's the first time in my life sawing an economic trough. After that, I began to know that as cold fear gripped financial markets and expectations of further slowdown ensued, firms cut down on investment spending.

A Peak

Before the Asian financial crisis, I think it's a booming economy situation or a peak while everything looks great and my father's business went successfully. During that period, you can see so much positive news on TV. The government tends to increase spending on welfare and healthcare, financial crimes are also rarely being talked.

When was the economy expanding? 

I believe it's a tremendous expanding from 1950 to 1980. The population of Taiwan increased from nearly six million to almost eighteen million, It's triple of the original population. Because of the increasing population, the needs of goods and services have also pushed the economy to a higher level.

When was it contracting?

The 2007-2008 Global Financial Crisis, also known as the 2008 Global Financial Crisis. The central banks in many countries have provided huge amounts of money in the financial market, they cannot stop the financial crisis. In September 2008, the financial crisis began to run out of control and causing the collapse of many large financial institutions or takeover by the government, triggering a recession.