MGT101 Financial Accounting GDB 1 Solution Fall 2013

Learning Objectives:

  • To develop an understanding over difference between Cash and Accrual Accounting Systems in real world scenarios.
  • To understand the practical implication and suitability of accounting systems/basis for business organizations.

Discussion Question:

Scenario – 1: Mr. Ahsan is running a small shop under the business name of Small General Store dealing in lighting equipment’s and allied items. He bought lighting equipment for selling in his store on 21st November, 2012 at a cost of Rs. 6,300. As per the purchase terms, he doesn’t has to pay the due amount for 40 days. He records this transaction on the same date of purchase. His accounting period ends on December 31st each year.

Scenario – 2: Mr. Farhan – the owner of Machines Trader sold machinery for Rs. 100,000 on 19th February, 2013 to Mr. Zahid with an agreement to allow him to pay after 30 days from the date of purchase. While, preparing business accounts, Mr. Farhan recorded this sale as an income during March 2013 on its receipt. His firm’s accounting year ends on March 31st each year.

Questions:

  1. Which accounting system is followed by Mr. Ahsan and Mr. Farhan for maintaining their business records?

Solution: Accrual Accounting system is used here as he is liable to pay the amount in future. An accrual accounting system is based on when the transaction happens rather than on when cash changes hands. Accrual accounting involves two fundamental principles—to recognize the business transaction, and to periodically adjust the financial statement so that the net income  for a given period will reflect a match between that period’s associated revenues and its expenses. In applying these principles, the periodic adjustments allow for the inclusion into the accounts of economic events that did not involve a business exchange or transaction, such as interest gained at the bank or depreciation of computer equipment.

  1. Which accounting system would you preferred for commercial organizations in Pakistan? Why?

Solution:  Cash Accouting system is used here. Because Mr. Farhan has consider the amount his revenue.In short, this is a straightforward system where transactions are documented as they occur. One records revenue as it comes in and expenses as they are paid. This type of accounting requires little subjective judgment as the timing (and the obviousness) of the transaction dictates when the journal entry is made. The drawback with this type of accounting is that it does not represent events which are not a business transaction or exchange, such assets or liabilities building up or expiring over time (examples being interest earned at the bank or the depreciation of computer hardware). This method is primarily useful for uncomplicated accounting situations, such as keeping the financial records of an individual.

 

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