Question

In its first year of operations, Pharoah company recognized $31,800 in service revenue, $6400 of which was on account and still outstanding at year end. The remaining $25400 was received in cash from customers.

The company incurred operating expenses of $16600. Of these expenses, $12730 were paid in cash; $3870 was still owed on account at year end. In addition, Pharoah prepaid $2390 for insurance coverage that would not be sued until the second year of operations.
Calculate the first year's net earnings under the cash basis of accounting and the first year's net earnings under the accrual basis of accounting.
What basis of accounting (cash or accrual) provides more useful information for decision makers?

Answer 1

Net income under cash basis:

= Revenues - Expenses

= ($31,800-$6,400) - ($12,730+$2390)

= $25,400 - $15,120

= $10,280

Net income under accrual basis:

= $31,800 - $16,600

= $15,200

The basis of accounting which provides more useful information for decision makers is the accrual basis because it entails the revenues and expenses for a specific period of time which make it easy for decision making.