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Running head: BRANDYWINE HOMECARE

Brandywine Homecare Patricia Barringer Strayer University Health Finance Management HSA 525 Dr. Merle Point-Johnson October 19, 2011

Brandywine Homecare Construct Brandywines 2007 income statement: 1. The Brandywine income statement is as follows:

Brandywine Income Statement

Revenue Expenses Gross Profit less Depreciation Expense Net Income

12,000,000 9,000,000 3,000,000

1,500,000 1,500,000

What were Brandywines 2007 net income, total profit margin, and cash flow? Brandywines net income was $1.5 million. The total profit margin, which we will assume is the net margin, is 1.5 million / 12 million = 12.5%. The cash flow is $3,000,000. The cash flow is the net income + depreciation, so 1.5m + 1.5m = 3m.

Suppose the company changed its depreciation calculation procedures (still within GAAP) such that its depreciation expense doubled, how would this change affect Brandywines net income, total profit margin, and cash flow? If the depreciation expense doubled, the income statement would be as follows:

Brandywine Income Statement Revenue Expenses Gross Profit less Depreciation Expense Net Income 3,000,000 0 12,000,000 9,000,000 3,000,000

The net income would drop to zero, as would the profit margin. The cash flows, however, would remain unchanged at $3m. This is because the depreciation expense has doubled. In doing so, it is now $3m, and when this is subtracted from the gross profit, the remaining money (net income) is now zero. However, depreciation is not a cash flow. Therefore, a change in the depreciation expense does not have any impact on the cash flow. Only changes to cash items will impact cash flows. Thus, the cash flows still remain at $3 million. Explain the difference between cash and accrual accounting. Be sure to include a discussion of the revenue recognition and matching principles.

Cash accounting is a system that only measures cash flows. As Gapenski states, The core argument in favor of cash accounting is the that the most important event to record is the receipt of cash, not the provision of the service. (Gapenski, 2008, p. 69) All items are recorded when the cash flow occurs. Accrual accounting refers to a system that records transactions when they take place, regardless of when the cash changes hands (no author, 2011). These differences take a number of forms. Typically, accrual accounting conforms to generally accept accounting principles (GAAP) while cash accounting does not. Thus, most businesses do not use cash accounting, perhaps with the exception of very small businesses. One of the differences between the two methods is with respect to revenue recognition. As the definitions explain, revenue is recorded in cash accounting when the cash is received. (Gapenski, 2008) Thus, if a sale is made in December and the account is settled in February, the transaction is not recorded until February. In accrual accounting, the same transaction would be recorded in December. This is because the transaction is recorded when it is accrued. To make this work, accrual accounting has two separate transactions to record that one sale. The first transaction would record a matching transaction to sales and to accounts receivable. When the account is settled, the accounts receivable transaction is matched with a cash transaction. One of the differences between the two methods is with respect to revenue recognition. As the definitions explain, revenue is recorded in cash accounting when the cash is received. (Gapenski, 2008) Thus, if a sale is made in December and the account is settled in February, the transaction is not recorded until February. In accrual accounting, the same transaction would be recorded in December. This is because the transaction is recorded when it is accrued. To make this work, accrual accounting has two separate transactions to record that one sale. The first transaction would

record a matching transaction to sales and to accounts receivable. When the account is settled, the accounts receivable transaction is matched with a cash transaction. Explain the difference between equity section of a not for profit business and an investorowned business. According to research, Investor-owned businesses have two sources of equity financing: retaining earning and new stock sales. Not for profit businesses can and do retain earnings, but they do not have access to the equity markets that is, they cannot sell common stock to raise equity capital. (No name, 2008, para. 5) On the balance sheet, the equity section of a not-forprofit business differs from that of a for-profit business. In a for-profit business, the equity section combines with liabilities to match the assets. This is because of the matching principle in accrual accounting. For every asset that is acquired, there must be an offsetting transaction. Thus, the asset must be acquired via debt or equity. If the asset cash from a profitable transaction, that will be offset into the equity side, usually as retained earnings. If the asset is purchased on credit, that will be reflected on the liabilities side. Each side of the balance sheet must balance, reflecting a series of offsetting transactions. Equity is simply what results whenever an asset is acquired without the use of some form of debt. In this context, equity reflects shareholder wealth. The equity is the value of the firm (its assets) once its obligations (liabilities) have been paid off. On a not-for-profit balance sheet, the function of equity is roughly the same, but with some differences. The balance sheet changes every day as a business increases or decreases its assets or changes the composition of its financing. (Gapenski, 2008, p. 94) What is similar is that not-for-profit equity is the value of the assets less the value of the debts. What is different is that equity in a not-for-profit entity does not reflect a shareholder entitlement. In a for-profit entity, the equity represents shareholder wealth, and the

shareholders have a claim on that equity. In a not-for-profit, equity capital can be acquired without any obligation. Grants and donations are both forms of assets that can be acquired by a not-for-profit entity. Unlike in a profit corporation, these assets are not acquired with the expectation of a return. This means that equity does not represent an obligation to shareholders. It is simply a reflection of how much of the entitys assets were not acquired with debt.

References No author. (2011). Cash vs. accrual accounting. Business Owners Toolkit. Retrieved October 21, 2011 from http://www.toolkit.com/small_business_guide/sbg.aspx?nid=P06_1340 No author. (2008). Equity in not-for-profit businesses. Car Free DC. Retrieved October 21, 2011 from http://www.carfreedc.info/2008/09/equity-in-not-for-profit-businesses/ (No Author, September 28, 2008). Equity in Not-for-Profit Businesses [Electronic mailing list message]. Retrieved from http://www.carfreedc.info/2008/09/equity-in-not-for-profitbusinesses/

Gapenski, L. C. (2008). Healthcare Finance (Fourth Edition ed.). Chicago,IL: Health Administration Press.