In Its First Year Of Operations, Grace Company Reports The Following: Earned Revenues Of $60,000 ($52,000 Cash Received From Customers); Incurred Expenses Of $35,000 ($31,000 Cash Paid Toward Them); Prepaid $8,000 Cash For Costs That Will Not Be Expensed Until Next Year. Net Income Under The Cash Basis And Accrual Basis Of Accounting Is:

In Its First Year Of Operations, Grace Company Reports The Following: Earned Revenues Of $60,000 ($52,000 Cash Received From Customers); Incurred Expenses Of $35,000 ($31,000 Cash Paid Toward Them); Prepaid $8,000 Cash For Costs That Will Not Be Expensed Until Next Year. Net Income Under The Cash Basis And Accrual Basis Of Accounting Is: A. $17,000 B. $21,000 C. $13,000 D. $25,000 E. None of these choices are correct.
Here, we are required to calculate Net Income (NI) of the business of Grace company for the current accounting period Under Cash Basis Of Accounting And Accrual Basis Of Accounting.

(i). Net Income Under Cash Basis Of Accounting (CBA)

Given:

Total Revenues = $52,000

Total Expenses = $31,000

As we know that formula used for the calculation of Net Income is:

 Net Income - Total Revenues - Total Expenses

By Putting the Values, we have:

Net Income = $52,000 - $31,000 = $21,000

So, the correct answer under cash basis of accounting is $21,000, i.e., the correct option of this multiple choice question is B.

(ii). Net Income Under Accrual Basis Of Accounting (ABC)

Given:

Total Revenues = $60,000

Total Expenses = $35,000 + $8,000 (Prepaid Expenses That Will Not Be Expensed Until The Next Year)

Total Expenses = $43,000

We know that Net Income, under this basis, is calculated by applying the following equation:

Net Income = Total Revenues – Total Expenses

By using the given values of total revenues and total expenses in the below equation, we have:

Net Income = $60,000 - $43,000 = $17,000

So, under accrual basis of accounting, the correct option is A i.e., $17,000.

After calculating NI under both methods, we conclude that accrual basis of accounting accounts for both aspects of transactions i.e., cash and credit aspects. In other words, this method of accounting records the transactions whether the cash is received / paid or not while cash basis of accounting only records the cash aspects, i.e., when the cash is received or paid. Moreover, NI under accrual basis is $17,000 which is less than $4,000 as compare to NI ($21,000) calculated under cash basis of accounting, so it provides more accurate results of financial data as compare to CBA and due to this reason, now a days, the most of the companies (smaller to medium and medium to larger) prefer to use ABC method rather than CBA method.

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