Question

In its first year of operations, Ivanhoe Company recognized $31,600 in service revenue, $7,700 of which was on account and still outstanding at year-end. The remaining $23,900 was received in cash from customers. The company incurred operating expenses of $16,100. Of these expenses, $12,010 were paid in cash; $4,090 was still owed on account at year-end. In addition, Ivanhoe prepaid $2,690 for insurance coverage that would not be used until the second year of operations.(a) Calculate the first year’s net earnings under the cash basis of accounting, and accrual basis of accounting.

(b) Which basis of accounting (cash or accrual) provides more useful information for decision-makers?

Answer 1

a) Calculate the first year’s net earnings under the cash basis of accounting, and accrual basis of accounting.

cash basis accrual basis

total revenue $23,900 $31,600

operating expenses $12,010 $16,100

prepaid insurance $2,690

net earnings $9,200 $15,500

b) the accrual basis always provides more useful information because transactions are recorded when they actually occur, not when cash flows (collections or payments) are directly associated to them. This is why the IRS only allows cash basis accounting for certain small businesses or sole proprietorships.