Problem 21 - Accounting

Question

Rejuvenation Physical Therapy Inc. is planning its cash payments for operations for the third quarter (July-September), 2011. The Accrued Expenses Payable balance on July 1 is \(\$ 24,000\). The budgeted expenses for the next three months are as follows: \begin{tabular}{lrrr} & \multicolumn{1}{rr}{ July } & August & September \\ \hline Salaries & \(\$ 58,200\) & \(\$ 63,500\) & \(\$ 74,500\) \\ Utilities & 5,300 & 5,600 & 7,100 \\ Other operating expenses & 48,500 & 52,700 & 58,200 \\ Total & \(\$ 112,000\) & \(\$ 121,800\) & \(\$ 139,800\) \end{tabular} Other operating expenses include \(\$ 10,500\) of monthly depreciation expense and \(\$ 600\) of monthly insurance expense that was prepaid for the year on March 1 of the current year. Of the remaining expenses, \(70 \%\) are paid in the month in which they are incurred, with the remainder paid in the following month. The Accrued Expenses Payable balance on July 1 relates to the expenses incurred in June. Prepare a schedule of cash payments for operations for July, August, and September.

Step-by-Step Solution

Answer

July: $94,630; August: $107,760; September: $123,300.

Step 1: Understand Accrued Liabilities

The starting point is the Accrued Expenses Payable balance of $24,000 on July 1, which represents unpaid expenses from June.

Step 2: Recognize Non-cash Expenses

Identify non-cash expenses in the given budget: monthly depreciation expense of $10,500 and prepaid insurance expense of $600. These expenses do not create a cash outflow during the quarter and should be excluded from cash payments.

Step 3: Calculate Remaining Operating Expenses

For each month, subtract non-cash expenses (depreciation \(10,500 and prepaid insurance \)600) from the total operating expenses to determine cash-based expenses: \July: \(112,000 - \)10,500 - \(600 = \)100,900\August: \(121,800 - \)10,500 - \(600 = \)110,700\September: \(139,800 - \)10,500 - \(600 = \)128,700.

Step 4: Determine Payments for Current Month Expenses

Seventy percent of these cash-based expenses are paid in the month incurred: \July: \(100,900 x 70% = \)70,630\August: \(110,700 x 70% = \)77,490\September: \(128,700 x 70% = \)90,090.

Step 5: Determine Payments for Previous Month Expenses

The remaining thirty percent of June's cash-based expenses are paid in July. Calculate the amount based on June's expenses already accrued in June: Accrued balance July 1 ($24,000) is considered paid in July. Thirty percent of July's cash-based expenses ($100,900 x 30% = $30,270) carry over to August, and thirty percent of August's cash-based expenses ($110,700 x 30% = $33,210) carry over to September.

Step 6: Schedule Cash Payments

Create the schedule for each month using calculated figures: \- **July Payments:** \(70,630 (June's accrued of \)24,000) \- **August Payments:** \(77,490 + \)30,270 = \(107,760 \- **September Payments:** \)90,090 + \(33,210 = \)123,300

Step 7: Compile Final Cash Payment Schedule

By now, we can compile a cash payment schedule as below.\July: \(94,630 (inclusive of June's accrued expenses)\August: \)107,760\September: $123,300

Key Concepts

Accrued Liabilities

Accrued liabilities are expenses that a company has incurred but hasn't yet paid. In our case, Rejuvenation Physical Therapy Inc. had an accrued liabilities balance of \( \$ 24,000 \) on July 1, representing costs from June that are to be paid in July. This means the company already benefited from the services or goods in June, yet the cash payment will happen in July. Understanding accrued liabilities helps in managing cash flows effectively, as it gives insight into upcoming cash obligations.

Accrued liabilities are important for cash flow planning because they show the company's commitments, even if these did not result in an immediate cash outflow. For businesses, proper understanding of accrued liabilities leads to better forecasting and budgeting. These liabilities must be kept in balance by ensuring adequate cash flow to cover the upcoming payments while staying prepared for any unexpected financial obligations.

Cash-Based Expenses

Cash-based expenses involve any costs that result in immediate cash outflow from a business. In our exercise, after removing the non-cash items (like depreciation and prepaid insurance), the remaining expenses for Rejuvenation Physical Therapy Inc. are termed cash-based expenses. These are critical because they reflect the actual cash that will be used in operations.

• July: \( \\( 100,900 \)
• August: \( \\) 110,700 \)
• September: \( \$ 128,700 \)

In practice, cash-based expenses help businesses understand how much liquidity is needed in a given period. Monitoring these expenses allows businesses to keep tabs on their financial health by ensuring they don't overspend. Planning cash payments based on cash-based expenses ensures that a company can meet its operational commitments without facing liquidity issues.

Non-Cash Expenses

Non-cash expenses, as the name suggests, do not require immediate cash outflow. They are accounting entries that decrease earnings but do not directly affect cash flow. In the context of our exercise, the two significant non-cash expenses are the depreciation expense of \( \\(10,500 \) per month and a monthly \( \\)600 \) prepaid insurance. Understanding these helps in differentiating between actual cash outflows and bookkeeping entries.

• Depreciation: Reflects the gradual wear and tear on assets. Though it doesn't involve current cash flow, capturing it ensures that asset costs are spread over their useful life.
• Prepaid Insurance: Represents an expense paid in advance for future benefits. It is recorded in the corresponding month's expense, although cash was paid upfront.

These expenses are vital for financial reporting as they affect the net income without changing cash positions. By identifying non-cash expenses, businesses can assess their true cash position and adjust strategies accordingly. It's crucial for companies to manage these effectively as they influence profitability and financial decision-making.

Depreciation Expense

Depreciation expense is a non-cash charge that businesses record to allocate the cost of a tangible asset over its useful life. For Rejuvenation Physical Therapy Inc., a monthly depreciation expense of \( \$10,500 \) was accounted for but didn't impact cash outflows during the third quarter.This concept is key to understanding the real financial state of a business. While no cash is exchanged, including depreciation in accounting helps reflect the wear and tear on assets over time. By consistently charging depreciation, companies can avoid large expense hits in financial periods when assets are replaced or repaired.Additionally, depreciation can have tax benefits as it often reduces the taxable income. To manage finances effectively, it's crucial for companies to track depreciation, providing a more accurate forecast of asset replacement needs and the true cost of asset usage over time. This plays a critical role in maintaining competitiveness and longevity in business.