Question

Samantha Dolan operates a small consulting business as a sole proprietor. During 2018, she has the following transactions related to the business:

Customer sales on account	$75,000
Collections from 2018 Credit Sales	$5,000
Collections from 2018 Credit Sales	$18,000
Business Bad debts	$8,000
Operating expenses incurred during 2018	$44,000
Operating expenses from 2018 paid in 2018	$33,000
Operating expenses from 2018 paid in 2018	$10,000

1. Calculate the net income or loss from Samantha’s business using the accrual method of accounting

2. Calculate the net income or loss from Samantha’s business using the cash method of accounting.

3. What accounts for the difference in the two net incomes and how does this benefit or cause a problem for a trade or business?

Note from instructor: I would just use both as displayed. I think they’re just trying to make you take into account multiple line items like you will in real life (but they would probably be named differently).

Answer 1

A)Under Accrual basis of accounting ,revenue is recognized at the time it is earned whether cash received or not is not relevant .Also expenses are recognized at the time it is incurred whether paid or not is irrelevant.

INCOME STATEMENT ACCRUAL BASIS OF ACCOUNTING
Sales revenue	75000
Less:operating expenses
Bad debt expense	8000
other operating expenses incurred	44000
Total expenses	(52000)
Net income	23000

2)Under cash basis of accounting ,revenue is recognized at the time cash is received and expenses is recognized at the time cash is paid.

INCOME STATEMENT CASH BASIS OF ACCOUNTING
Sales revenue (5000+18000)	23000
Less:operating expenses
operating expenses incurred {33000+10000}	43000
Total expenses	(43000)
Net income	(20000)

3)

Income as per accrual basis of accounting		23000
Add/(less)
Revenue not yet collected [75000-5000-18000]	-52000
Expenses not yet paid [44000-33000-10000]	1000
Bad debt expense being non cash expense	8000
		-43000
Income as per cash basis of accounting		-20000

The accrual basis of accounting records transaction when they are actually incurred however cash basis of accounting records transactions in the year in which they are received or paid irrelevance to period of incurrence .

Thus the cash basis of accounting does not show the correct or true picture of financial statement .