You are to assume the role of an associate accountant hired by the owner of Locally Picked, LLC., a small business that sells fresh locally grown fruits, vegetables and honey. The owner needs you to explain accrual basis accounting.
Locally Picked, LLC is growing and has started selling its items to larger grocery chains in the region. As a small farmer’s market, the owner had always used cash basis accounting. The owner was recently told that they should be using accrual basis accounting and does not understand the reason.
The owner has been selling fruits, vegetable and honey to the grocery store chain and billing the store. The owner was told that revenue must be recorded at the time of the sale, but the owner feels that does not make sense since revenue has not been received because cash has not been received. The owner needs your help understanding this concept and why accrual basis accounting is the preferred method.
The owner has listed three transactions that are in dispute:
- June 10th, sold fruits, vegetables, and honey to the grocery store for $1,000 and billed the grocery store with terms 2/10, n/30.
- June 20th purchased a refrigerator for $2,000, did not pay at the time of purchase, was billed for it, and will pay for it in July.
- June 30th prepaid liability insurance for $3,000 that covers the last six months of the year.
You are to meet with the owner to:
- Explain how accrual basis accounting works and why it is preferred over cash basis accounting.
- Discuss the definition of accounts receivable and accounts payable.
- Go over the three transactions above and demonstrate how they should be recorded under accrual basis accounting.
