During a specific accounting period, a hospital has earned $1,500,000 in revenues and consumed $600,000 in resources. Consider the following three scenarios. In scenarios A and B, cash basis of accounting method is followed. In scenario C, accrual basis of accounting rules are followed.

Scenario A - management wants the financial statements to show high profit, it delays paying the bills until after the accounting period, although full payment of $1,500,000 is collected.

Scenario B - management wants the financial statements to show low profit, maybe in order to encourage donations. It discourages patients and third-party payors from paying until after the accounting period. All the bills, $600,000, get paid on time.

Scenario C - according to accrual basis of accounting method, the financial statements report revenues, $1,500,000, when revenues are earned; and expenses expended to generate those revenues of $600,000, when resources are used.

Reported records

Scenario A

Scenario B

Scenario C

Revenues

$1,500,000

$0

$1,500,000

Expenses

$0

$600,000

$600,000

Profit

$1,500,000

($600,000)

$900,000

1. Discuss how the cash basis of accounting is vulnerable to management's manipulation and how the accrual basis of accounting overcomes the disadvantages of the cash basis of accounting.
2. When looking at a capital investment into a project for an organization, management needs the board's approval for the funds. Because of this need for approval, there is sometimes a tendency to overstate revenue and understate expenses associated with the project. Why do you feel that management would overstate revenue and understate expenses? What are the consequences of doing this?

Your comments will be graded on how well they meet the Discussion Requirements posted under "Before You Begin."