The Matching Principle of accounting states that we shouldrecord revenues and the expenses related to those revenues in thesame period. If we did not adopt the Matching Principle ofaccounting, what would be the effect on our financial statements inthe short term, and in the long term? Adopting the MatchingPrinciple of accounting requires that accountants do more work. Isit really worth the additional effort?
The Matching Principle of accounting states that we shouldrecord revenues and the expenses related to those revenues in thesame period. If we did not adopt the Matching Principle ofaccounting, what would be the effect on our financial statements inthe short term, and in the long term? Adopting the MatchingPrinciple of accounting requires that accountants do more work. Isit really worth the additional effort?
Related questions
I am unsure of what is unclear. The instructions are:
1. Set up a worksheet for the solvency ratios--currentratio and the quick ratio.
2. Compute these ratios for Doctors Smith and Brown. Todo so, you will need one additional piece of information that isnot present on the doctorsâstatements: their maximum annual debt service is$22,200.
Practice Exercise 11âII: Solvency Ratios
Refer to Doctors Smith and Brownâs financial statementspresented in the preceding Chapter 10.
Required
1. Set up a worksheet for the solvency ratios. current ratio and the quick ratio.
2. Compute these ratios for Doctors Smith and Brown. Todo so, you will need one additional piece of information that isnot present on the doctorsâstatements: their maximum annual debt service is$22,200.
The requested information is below:
Exhibit 10-1 Westside Clinic Balance Sheet
Assets | December 31, 20x2 | December 31, 20x1 | ||
Current Assets | ||||
Cash and cash equivalents | $190,000 | $145,000 | ||
Accounts receivable (net) | 250,000 | 300,000 | ||
Inventories | 25,000 | 20,000 | ||
Prepaid Insurance | 5,000 | 3,000 | ||
Total Current Assets | $470,000 | $468,000 | ||
Property, Plant, and Equipment | ||||
Land | $100,000 | $100,000 | ||
Buildings (net) | 0 | 0 | ||
Equipment (net) | 260,000 | 300,000 | ||
Net Property, Plant, and Equipment | 360,000 | 400,000 | ||
Other Assets | ||||
Investments | $133,000 | $32,000 | ||
Total Other Assets | 133,000 | 32,000 | ||
Total Assets | $963,000 | $900,000 | ||
Liabilities and Fund Balance | ||||
Current Liabilities | ||||
Current maturities of long-term debt | $52,000 | $48,000 | ||
Accounts payable and accruedexpenses | 293,000 | 302,000 | ||
Total Current Liabilities | $345,000 | $350,000 | ||
Long-Term Debt | $252,000 | $300,000 | ||
Less Current Maturities of Long-Term Debt | ?52,000 | ?48,000 | ||
Net Long-Term Debt | 200,000 | 252,000 | ||
Total Liabilities | $545,000 | $602,000 | ||
Fund Balances | ||||
Unrestricted fund balance | $418,000 | $298,000 | ||
Restricted fund balance | 0 | 0 | ||
Total Fund Balances | 418,000 | 298,000 | ||
Total Liabilities | $963,000 | $900,000 | ||
Exhibit 10-2 sets out the result of operations for two years,with the most current period in the left column. If the balancesheet is a snapshot, then the statement of revenue and expenses isa diary because it is a record of transactions over the period of ayear. Operating revenues and operating expenses are set out first,with the result being income from operations of $115,000($2,000,000 less $1,885,000). Then other transactions are reported;in this case, interest income of $5,000 under the headingâNonoperating Gains (Losses).â The total of $120,000 ($115,000 plus$5,000) is reported as an increase in fund balance. This figurecarries forward to the next major report, known as the statement ofchanges in fund balance.
STATEMENT OF CHANGES IN FUND BALANCE/NET WORTH
Remember that our formula for a basic statement of revenue andexpense looked like this:
Operating Revenue â Operating Expenses = Operating Income
Exhibit 10-2 Westside Clinic Statement of Revenue andExpenses
For the Year Ending | |||||
Revenue | December 31, 20x2 | December 31, 20x1 | |||
Net patient service revenue | $2,000,000 | $1,850,000 | |||
Total operating revenue | $2,000,000 | $1,850,000 | |||
Operating Expenses | |||||
Medical/surgical services | $600,000 | $575,000 | |||
Therapy services | 860,000 | 806,000 | |||
Other professional services | 80,000 | 75,000 | |||
Support services | 220,000 | 220,000 | |||
General services | 65,000 | 60,000 | |||
Depreciation | 40,000 | 40,000 | |||
Interest | 20,000 | 24,000 | |||
Total operating expenses | 1,885,000 | 1,800,000 | |||
Income from Operations | $115,000 | $50,000 | |||
Nonoperating Gains (Losses) | |||||
Interest Income | $5,000 | $2,000 | |||
Net nonoperating gains | 5,000 | 2,000 | |||
Revenue and Gains in Excess of | |||||
Expenses and Losses | $120,000 | $52,000 | |||
Increase in Unrestricted Fund Balance | $120,000 | $52,000 | |||
The excess of revenue over expenses flows back into equity orfund balance through the mechanism of the statement of fundbalance/net worth. Exhibit 10-3 shows a balance at the first of theyear; then it adds the excess of revenue over expenses (in theamount of $115,000) plus some interest income (in the amount of$5,000) to arrive at the balance at the end of the year.
If you refer back to the balance sheet, you will see the$418,000 balance at the end of the year appearing on it. So we canthink of the balance sheet, the statement of revenue and expenses,and the statement of changes in fund balance/net worth as lockedtogether, with the statement of changes in fund balance being themechanism that links the other two statements.
But there is one more major reportâthe statement of cashflowsâand we will examine it next.
STATEMENT OF CASH FLOWS
To perceive why a statement of cash flows is necessary, we mustfirst revisit the concept of accrual basis accounting. If cash isnot paid or received when revenues and expenses are entered on thebooksâthe usual situation in accrual accountingâwhat happens? Theother side of the entry for revenues is accounts receivable, andthe other side of the entry for expenses is accounts payable. Theseaccounts rest on the balance sheet and have not yet been turnedinto cash. Another characteristic of accrual accounting is therecognition of depreciation. A capital assetâa piece of equipment,for exampleâis purchased for $20,000. It has a usable life of fiveyears. So depreciation expense is recognized in each of the fiveyears until the $20,000 is used up, or depreciated. (Land is anexception to this rule: it is never depreciated.) Depreciation isrecognized within each year as an expense, but it does notrepresent a cash expense. This is a concept that now enters intothe statement of cash flows.
Exhibit 10-4 presents the current period cash flow. In effect,this statement takes the accrual basis statements and converts themto a cash flow for the period through a series of reconcilingadjustments that account for the noncash amounts.
Understanding the cash/noncash concept makes sense of thisstatement. The starting point is the income from operations, thesubtotal from the statement of revenue and expense. Depreciationand interest are added back, and changes in asset and liabilityac-counts, both positive and negative, are recognized. Theseadjustments account for operating activities. Next, capital andrelated financing activities are addressed; then investingactivities are adjusted. The result is a net increase in cash andcash equivalents of $45,000 in our example. This figure is added tothe cash balance at the beginning of the year ($145,000) to arriveat the cash balance at the end of the year ($190,000). Now referback to the balance sheet, and you will find the cash balance isindeed $190,000. So the fourth major reportâthe statement of cashflowsâinterlocks with the other three major reports.
Exhibit 10-3 Westside Clinic Statement of Changes in FundBalance
For the Year Ending | |||
Statement of Changes in Fund Balance | December 31, 20x2 | December 31, 20x1 | |
Balance First of Year | $298,000 | $246,000 | |
Revenue in Excess of Expenses | 115,000 | 50,000 | |
Interest Income | 5,000 | 2,000 | |
Balance End of Year | $418,000 | $298,000 | |
Exhibit 10-4 Westside Clinic Statement of Cash Flows
Statement of Cash Flows | For the Year Ending | |||
December 31, 20x2 | December 31, 20x1 | |||
Operating Activities | ||||
Income from operations | $115,000 | $50,000 | ||
Adjustments to reconcile income from | ||||
operations to net cash flows from | ||||
operating activities | ||||
Depreciation and amortization | 40,000 | 40,000 | ||
Interest expense | 20,000 | 24,000 | ||
Changes in asset and liabilityaccounts | ||||
Patient accountsreceivable | 50,000 | â250,000 | ||
Inventories | â5,000 | â5,000 | ||
Prepaid expenses andother assets | â2,000 | â1,000 | ||
Accounts payable andaccrued expenses | â9,000 | 185,000 | ||
Net cash flow from operating activities | $209,000 | $43,000 | ||
Cash Flows from Noncapital Financing Activities | 0 | 0 | ||
Cash Flows from Capital and Related Financing ActivitiesAcquisition of equipment | $ 0 | $(300,000) | ||
Proceeds from loan for equipment | 0 | 300,000 | ||
Interest paid on long-term obligations | â20,000 | 0 | ||
Repayment of long-term obligations | â48,000 | 0 | ||
Net cash flows from capital and related financing activities | â68,000 | 0 | ||
Cash Flows from Investing Activities | ||||
Interest income received | $5,000 | $2,000 | ||
Investments purchased (net) | â 101,000 | 0 | ||
Net cash flows from investing activities | â96,000 | 2,000 | ||
Net Increase (Decrease) in Cash and Cash Equivalents | $45,000 | $45,000 | ||
Cash and Cash Equivalents, Beginning of Year | 145,000 | 100,000 | ||
Cash and Cash Equivalents, End of Year | $190,000 | $145,000 | ||
