Fun Play, a maker of electronic games for kids, has just completed its first year of operations. The company’s sales growth was explosive. To encourage large national stores to carry its products Fun Play offered 180 day financing—meaning its largest customers do not pay for nearly 6 months. Because Fun Play is a new company, its components suppliers insist on being paid cash on delivery. Also, it had to pay up front for 2 years of insurance.
At the end of the year Fun Play owed employees for one full month of salaries, but due to a cash shortfall, it promised to pay them the first week of next year.
Instructions
(a) Explain how cash and accrual accounting would differ for each of the events listed above and describe the proper accrual accounting.
(b) Assume that at the end of the year Fun Play reported a favorable net income, yet the company’s management is concerned because the company is very short of cash. Explain how Fun Play could have positive net income and yet run out of cash.