Refer to Case 2–1. Mr. Pitt has relented and agrees to provide you with the information necessary to convert his cash basis financial statements to accrual basis statements. He provides you with the following transaction information for the fiscal year ending December 31, 2021: 

1. A new comprehensive insurance policy requires an annual payment of $12,000 for the upcoming year. Coverage began on September 1, 2021, at which time the first payment was made. 

2. Mr. Pitt allows customers to pay using a credit card. At the end of the current year, various credit card companies owed Mr. Pitt $6,500. At the end of last year, customer credit card charges outstanding were $5,000. 

3. Employees are paid once a month, on the 10th of the month following the work period. Cash disbursements to employees were $8,200 and $7,200 for January 10, 2022, and January 10, 2021, respectively. 

4. Utility bills outstanding totaled $1,200 at the end of 2021 and $900 at the end of 2020. 

5. A physical count of inventory is always taken at the end of the fiscal year. The merchandise on hand at the end of 2021 cost $35,000. At the end of 2020, inventory on hand cost $32,000. 

6. At the end of 2020, Mr. Pitt did not have any bills outstanding to suppliers of merchandise. However, at the end of 2021, he owed suppliers $4,000. 

Required: 

1. Mr. Pitt’s 2021 cash basis net income (after one adjustment for depreciation expense) is $26,000. Determine net income applying the accrual accounting model. 

2. Explain the effect on Mr. Pitt’s balance sheet of converting from cash to accrual. That is, would assets, liabilities, and owner’s equity be higher or lower and by what amounts? 

Data From Case 2-1

You have recently been hired by Davis & Company, a small public accounting firm. One of the firm’s partners, Alice Davis, has asked you to deal with a disgruntled client, Mr. Sean Pitt, owner of the city’s largest hardware store. Mr. Pitt is applying to a local bank for a substantial loan to remodel his store. The bank requires accrualbased financial statements, but Mr. Pitt has always kept the company’s records on a cash basis. He doesn’t see the purpose of accrual-based statements. His most recent outburst went something like this: “After all, I collect cash from customers, pay my bills in cash, and I am going to pay the bank loan with cash. And, I already show my building and equipment as assets and depreciate them. I just don’t understand the problem.”