Question

2. The Larson Company prepared the following income statement using the cash basis of
accounting:

THE LARSON COMPANY
Income Statement, Cash Basis
Year Ended December 31, 2017
Service revenue $460,000
Expenses 220,000
Profit $240,000

Additional data:
1. Service revenue includes $40,000 collected from a customer for whom services
were provided in 2016, and who was billed in 2016.
2. There are an additional $15,000 of expenses that were incurred on account, for
which payment will not be made until 2018.
3. Depreciation on a company automobile for the year amounted to $7,000. This
amount is not included in the expenses above.
4. On December 1, 2017, paid $1,600 for two months' rent (December and January).
This amount is included in the expenses above.

Instructions
a) Prepare Larson's income statement on the accrual basis in conformity with
generally accepted accounting principles. Show calculations and explain each change.
b) Explain which basis (cash or accrual) provides a better measure of profit.

Answer 1

a.

Income Statement on accrual basis
for the period ending on 31st December, 2017
Particulars	Amount
Service Revenue (WN 1)	420,000
Expenses (WN 2)	241,200
Profit	178,800
WN 1: Calculation of Service Revenue on accrual basis
Particulars	Amount
Service revenue on cash basis	460,000
Less: Service revenue not related to 2017	40,000
Service revenue on accrual basis for 2017	420,000
WN 2: Calculation of Expenses on accrual basis
Particulars	Amount
Expenses on cash basis	220,000
Add: Expenses incurred for 2017 outstanding till 2018	15,000
Add: Depreciation	7,000
Less: Rent paid for December 2017 and January 2018 (1600 / 2)	800
Expenses on accrual basis for 2017	241,200

b.

Accrual basis provides a better measure of profit because while booking expenses and revenues on accrual basis, the organisation books all items related to the year in consideration. However, in case of cash basis, the financial statements does not represent correct picture, as the amounts paid for the years other than consideration are shown in financial statements.