 Hello and welcome to the session in which I will cover converting from cash to accrual. One of the most dreaded topics for many CPA candidates and intermediate accounting students. It's critical that you become very comfortable converting from cash to accrual, because eventually you're going to go from accrual to cash. So knowing how to switch between those two accounts tells the CPA examiner, the AICPA that you know basic journal entries, you know how to work a T-account. Although in this session I'm going to avoid working T-accounts, I'm going to explain this concept in a simple, in the most simplest way I can. But not knowing how to convert back and forth is critical for your success, also as a practitioner. You will see that many small firms use cash basis accounting and you will need to convert to accrual. So it's very important in practice to know this. 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Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So the first thing we want to know is what is the cash basis accounting? Cash basis accounting basically state you recognize revenue when you receive it in cash. You record expenses when you pay it in cash. So simply put, it's cash basis. Most of us as individual, we work on a cash basis. We assume we have an expense when we pay it. We assume we have a revenue when we receive it. A cruel basis is a little bit different. A cruel basis is we record revenues when we earned the revenue, not when we receive the cash. Sometimes we might receive cash upfront. It's not revenue. Sometimes we may not receive the cash until we perform the service. Regardless, cash revenue is recorded when earned. Expenses follow the same concept. Expenses are recorded when incurred. What does that mean? It means it doesn't matter when you pay the expense. What matters is did the expense actually happened? If it actually happened, it belonged to this period, you would record the expense in this period. Whether you paid it later or sometime you might pay it for some expenses upfront, which are called prepaid. So this is the cruel basis of accounting. Now again, why do we need to learn about this? Well, many small businesses use the cash basis. I can assure you, when I was in practice, we had many MDs, medical doctors, that they use the cash basis of accounting where we had to convert to a cruel basis. And obviously, it's tested on the CPA exam, you need to know this. So what I'm going to do, I'm going to split this recording into two sections. First, I'm going to convert cash revenue to a cruel revenue, then I'm going to convert cash expense to a cruel expense. Starting with revenues. Two account usually affect the cruel revenues. And those are account receivable and un-earned revenue. On this slide, I will show you how to convert to a cruel revenues if you have to deal with receivable. On the next slide, I will deal with un-earned revenue. So how do we convert from cash to a cruel? Well, first we're going to start with cash receipts from customers. And that's usually given in the problem. And in the real world, you can take a look at the QuickBooks of that customer, at their bank balance, at their bank transaction, and you will see how much cash they received. Then what you do is you deduct beginning account receivable. And you can memorize this. You can add ending receivable. You can memorize this to come up with a cruel basis of revenue. So if you want to memorize this, I don't suggest you do that, but that's the formula. Now I'm going to explain to you why we deduct beginning account receivable and why we add ending receivable. Because under the exam pressure, your memory might fail you. But if you understand them, if you understand why, you'll be able to answer any questions and it will take more effort if you know why. So again, cash receipts will be given. Beginning account receivable will also be given to you. Now in the real world, it will be given because you would look at the prior year a cruel financial statements or the prior period and they will have an account receivable. Now why do we deduct account receivable? Well why do we deduct account receivable? Because think about it. If we have an account receivable on the financial statements from the prior period, it means that revenue has been recorded. For an account receivable to exist, you have to have a revenue against the receivable. So when we deduct account receivable, we credit revenue. If we see that we have a beginning account receivable, it means the revenue was already recorded in the prior period. The work has been done. It's done. That account receivable take it out because I want my accrual basis of revenue this period, the beginning period take it out. Now why do I add ending receivable? In a sense, the opposite concept. Now how do I know my ending receivable? On the CPA exam, in intermediate accounting, that number is giving. Ending receivable. In the real world, what you do, usually the client tells you, I did some work, I did not build them, I did not build the customers yet, or you just ask them, could you tell me if you did any work that's not on the books? And usually they write on a piece of paper, I did this work for this client, I haven't built them, make sure it's included in my revenue. When we compute ending receivable, we add ending receivable because that's work done. Now ending receivable, we debit AR, credit revenue, but this is the receivable for this period. Therefore we add it. We wanted the revenue to reflect in the accrual of revenue. So that's why we deduct the beginning because that's receivable belong to the prior period. Revenue belong to the prior period. We add ending receivable because it's revenue belongs to this period. So you only have receivable if you have revenue, okay? And you'll get to this. Let's work an example. Cash receipts from customers was 110,000 for a particular doctor for a quarter. Beginning account receivable was 22,000. This is from the prior period. You prepared the record and you know the beginning is the prior period ending. An ending receivable should be 15. And the reason I say should be 15 because you usually have to find out how much it should be in a sense you will talk to someone, say, okay, we did this work, we did not build a client yet. Let's use this formula to, I'm not going to use T accounts because if I use T accounts I complicate matters. If you know how to do this, you should know how to do a T account. So basically I'm going to take my cash receipts minus the beginning plus the ending and my accrual revenue should be 103. All what I did is I took my cash receipts and I convert into accrual revenue. That's all what I did. So notice in this period I received more cash, more cash than I build the client because notice my beginning was 22, my ending is seven. It means I received $7,000 in cash if you really think about it, that was revenue from the prior period. Okay, I received it in cash, it's included in cash, but when I see the difference because notice the beginning was 20, the ending was the end, I'm sorry, the beginning was 22, the ending was 15, it means my AR went down by $7,000, means I collected cash of $7,000 and that's not revenue, okay, because my receivable went down. But again, I explained to you the logic behind it. The second account that affect revenue is unearned revenue. Unearned revenue is a liability, so you have to understand how unearned revenue will affect. First, you're going to be giving cash receipts from customers that's going to be given to you. Then you're going to add beginning unearned revenue. Then you're going to deduct ending unearned revenue and you will come up with a cruel basis of accounting. Now, again, you can memorize this or you can try to understand why we do so and I believe understanding is better. Why do we add beginning unearned revenue? Well, think about it, at the beginning of the period you had a number, $10,000 of unearned revenue. What's going to happen this period unearned revenue turns into revenue? Because what we do, the unearned revenue, we're going to debit unearned revenue. When the period starts, you're going to debit unearned revenue and credit revenue. So you turn it into revenue. Therefore you add beginning unearned revenue to come up to revenue. So hold on a second. What happened if we did not do the work? Well, guess what? We're going to deduct any ending unearned revenue. So any work done, any beginning unearned revenue, we assume the work to be done this period, therefore a turn into revenue, and we'll deduct any unearned revenue Why? Because we received some cash and if it's unearned revenue, we have to take it out. When we receive the cash, what happened under the cash basis? We debit the cash credited revenue under the cash basis. Now we are told some, let's assume it's $5,000. Now we are told we made the mistake. This $5,000 was for the surgery that's going to be done next month. Well, guess what? Then we have to debit revenue and credit unearned revenue of $5,000. We have to put it into ending unearned revenue. Therefore we take ending revenue out because it's work to be done for next period. And this is how we convert unearned revenue to accrual revenue. Basically, let's take a look at an example. Cash receipts from a customer was $110,000. Beginning unearned revenue was $3,000 and ending unearned revenue was $8,000. Let's follow the instruction. We started with $110,000. We add the beginning unearned revenue. We assume we earned it. Then we subtract some unearned revenue. So we end up happening with $105,000 revenues under the accrual basis. Simply put, in other words, we received $2,000 more in cash this period that for work to be done next period. How do I know this? Because my ending increased by $2,000 in the beginning. It means there was an additional $2,000. I should have $103,000, $108,000, sorry. I'm glad I catch it because I said worthy $2,000. Why is it $105,000? So basically $110,000 plus $3,000 minus $5,000 equal to $108,000. So my accrual revenue is $108,000. As I was saying, simply put, I received $2,000 more in accrual and unearned revenue this period than the prior period. Therefore, I had to reduce my, that's the net. The net is $2,000. Ending unearned revenue was higher. It means I received $2,000 in net, $2,000 more in cash that for work to be done next period. This is how you convert revenues. Let's talk about expenses. Two accounts usually affect accrual expenses, and those are prepaid expenses and accrual expenses. Well, let's start with prepaid expenses. Well, first what we start with is cash paid for operating expenses. That's always giving and the problem or in the real world. Then what we do is we add beginning prepaid expenses and prepaid could be prepaid rent, prepaid insurance, supplies. We have many types of prepaid. They all work the same way. Then we will deduct ending prepaid. Then we come up with accrual expenses. Now again, you can memorize why we do this or you can understand why. Let's see why. Why do we add the beginning prepaid? We add beginning prepaid because this prepaid that was cash paid in the prior period and what happened to prepaid, eventually prepaid get expensed. That's what happened to prepaid. We prepaid for something, then as time goes by or as we use it or as we consume it, it turns into an expense. Therefore, if we're trying to find out what's our accrual expense, we need to add up our beginning prepaid. Again, because it's cash paid, but now it's gonna be expensed. Why do we deduct ending prepaid? Well, ending prepaid is cash paid to purchase the prepaid. So when we increase our prepaid, so whatever end up in our prepaid, it means it's an asset. What do we need to do with that? We need to take it out of expenses. And by doing so, we can convert our cash paid for operating expenses to accrual expenses. Let's take a look at this example. The company paid $40,000 cash for insurance during the fiscal year. At the beginning of the year, prepaid was 10,000. At the end of the year, the prepaid was six. Let's follow the instruction. 40,000 cash paid at the beginning to our expenses because we assume it's gonna, we're gonna expense it then deduct the ending because the ending has to be taken out because when we paid for those, whatever we purchase this period, we assume it's an expense. But it's not an expense. It's a prepaid and it's reflected in the ending. Therefore, if we net the change, notice what happened is we had $4,000 more in beginning. Yes, $4,000 more. What does that mean? If we have $4,000 more in prepaid at the beginning, it was expense this period. So the beginning was higher. It means our prepaid went down. Notice the prepaid went from 10 to six. And what happened when prepaid goes down? Expenses go up. Therefore, that's why I'll take my cash paid plus the difference will give me 44,000. Again, I'll try to explain the logic but follow the formula if you're not comfortable, think about it, reflect on it and believe me, it will make sense. Let's take a look at accrued expenses. Accrued expenses again will affect cash expenses. Now we're converting cash expenses to accrual. We start with cash paid for operating expenses. Then we will deduct any accrued expenses. We add any ending accrued expenses and we'll come up with accrued expenses. The question is why do we do so? Let's think about each one separately. Oops, should be a little bit higher. Why do we deduct beginning accrued expenses? Think about it, what are accrued expenses? Accrued expenses are when we debit an expense and credit a payable. And guess what? We have a balance of those as of the beginning of the period. Well, guess what? We already accrued the expense. So deduct the expense from this period. So deduct the beginning any accrued expenses. And accrued expenses could be accrued salaries, accrued interest, accrued any expense. Any expenses could be accrued. Then add any accrued expenses. Why do we add any accrued expenses? Because if we have any accrued expenses, that means we debit the expenses, we credit a payable, but it's for this period. The ending will be for this period. The beginning will be for the prior period. So take out the beginning and add the ending. And you will come up with your accrued expenses. Let's take a look at an example. Company paid 300,000 for salaries to employee during the year, this is for the year. The beginning salary payable was 24. And we determined that the ending should be 36. Let's look at the numbers. 300,000 minus the beginning plus the ending, it means in expenses we should have 312,000 in accrued expenses. Does that make sense? Yes, it does. If I paid 300,000 and my accrued expenses went up by 12, my accrued expenses went up by 12, it means net, I debited expenses, credited payable net for the year 12,000. It means net means the difference overall is more of 12,000. So I have more expenses and payable means accrued expenses, I will add it to my cash, I will come up with my accrued expenses. And I hope this makes sense. I hope this makes sense. Look, can we combine all those four scenarios at the same time? Sure we can. I looked at each scenario separately, but in a simulation you might see them all together. On a problem on the CPA exam or in intermediate accounting, you may see them all together. Rather than giving beginning and ending, you could be giving the information like this, beginning balances and ending balances. Take the difference between them. It's not a big deal. Again, this topic is challenging for many. I hope I simplified it. At the end of this recording, I'm gonna remind you again, I don't replace your CPA review course. I'm a useful addition. I can help you understand the material differently. Give me a shot, invest for a month, see if it helps you, that's your risk. If it helps, keep it. If not, your risk is one month, move on with your life, cut your losses. I assure you, I can help you. I have helped hundreds if not thousands. Take a look at it. Stay safe. The CPA is worth it and study hard.