E3 19a Book Static During 2016 Nicholson Network Inc

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During 2016, Nicholson Network, Inc., which designs network servers, earned revenues of $800 million. Expenses totaled $570 million. Nicholson collected all but $21 million of the revenues and paid $600 million on its expenses. The managers need to evaluate the financial performance and position of the company for the year 2016, focusing on understanding revenue and expense recognition under different accounting bases, and which financial statements report these figures.

Paper For Above instruction

The core of Nicholson Network Inc.’s financial analysis for 2016 involves understanding the appropriate recognition of revenue and expenses under accrual and cash basis accounting, as well as identifying the relevant financial statements. These aspects are vital for accurate financial reporting and effective managerial decision-making.

Accrual Basis Accounting and Revenue Recognition

Under accrual basis accounting, revenues are recognized when earned, regardless of cash collection. For Nicholson Network Inc., the revenue earned in 2016 amounts to $800 million, representing the total amount earned from network server designs during the year. The company's collection of all but $21 million indicates that $779 million was actually received in cash, but under accrual accounting, the focus is on when the revenue was earned, not when cash was received. Therefore, Nicholson should report $800 million as revenue for 2016. This approach aligns with the revenue recognition principle, which states that revenues should be recognized when associated with the completion of performance obligations that transfer control of goods or services to customers.

In the context of Nicholson Network Inc., the revenue principle emphasizes that revenue is considered earned when the network servers are designed and delivered, not necessarily when the cash is collected. This method provides a more accurate picture of performance during the period by matching revenues earned to the expenses incurred to generate them.

Accrual Basis and Expense Recognition

Regarding expenses, Nicholson incurred a total of $570 million, yet paid only $600 million during 2016, with $21 million uncollected. Under accrual accounting, expenses are recognized when they are incurred, not when paid. Thus, Nicholson must report $570 million as expenses for 2016, reflecting the costs associated with providing network design services during the period.

The matching principle supports this treatment, as it ensures that expenses are recorded in the same period as the revenues they help generate. This principle enhances the accuracy of net income measurement and the representation of financial position, providing managers and investors with relevant information about profitability.

Cash Basis Accounting: Recalculation and Comparison

When redoing the figures using the cash basis, revenues are recognized only when cash is received, and expenses only when cash is paid. Nicholson received $779 million in cash (total revenues of $800 million minus $21 million uncollected), and paid $600 million on expenses. Under cash basis, revenues reported are $779 million, and expenses are $600 million.

The main difference between the accrual and cash bases lies in timing: accrual basis matches income and expenses to when they are earned or incurred, offering a more accurate depiction of financial performance, while cash basis records transactions only when cash changes hands, which can distort profitability and financial condition.

Financial Statements Reporting Revenues and Expenses

The Income Statement reports revenues and expenses, providing a measure of profitability over a period. In contrast, the Statement of Cash Flows reports cash receipts and payments, giving insight into the company's liquidity and cash management during the period.

Conclusion

Understanding the principles and differences between accrual and cash basis accounting is essential for evaluating Nicholson Network Inc.'s financial health accurately. Using accrual accounting, the company recognizes its total revenue of $800 million and expenses of $570 million for 2016, yielding a clear picture of its operational performance. The income statement offers insights into profitability, while the cash flow statement reflects liquidity and cash management efficacy, both critical for stakeholders' decision-making.

References

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