Cash Basis & Accrual

Basis
■ Cash Basis

 Revenue is reported on the income statement only when cash is received. Expenses are only recorded
when cash is paid out.
 The cash method usually works better for smaller businesses that don’t carry inventory.

Revenue Recognition:
If you sell $5,000 worth of machinery, under the cash method, that amount is not recorded in the books
until the customer hands you the money or you receive the check.
Expense Recognition:
If you receive an electric bill for $1,700, under the cash method, the amount is not added to the books until
you pay the bill.
  Example Problem:

On February 1, 2019, Tory began a service proprietorship with an initial cash investment of P200,000. The
proprietorship provided P500,000 of services in February and received full payment in March. The
proprietorship incurred expenses of P300,000 in February, which were paid in April. During March, Tory
drew P100,000 against the capital account. In the proprietorship's financial statements for the two months
Solution:
ended March 31,2019, prepared under the cash basis method of accounting, what amount should be reported
as Cash investment P200,000 capital?

Service revenue P500,000

Withdrawals (P100,000)
Capital 03/31/2019 P600,000

■ Accrual Accounting Method

 Revenue is accounted for when it is earned. Typically, revenue is recorded before any money changes
hands.
 The accrual method records revenue when a product or service is delivered to a customer with the
expectation that money will be paid in the future. Expenses of goods and services are recorded despite
no cash being paid out yet for those expenses.
 GAAP Require that a business use the accrual basis because accrual basis gives a more realistic idea of
income and expenses during a period of time, therefore providing a long-term picture of the business
that cash accounting can’t provide.
 Example Problem:

During 2019, Ward collected P200,000 in fees from clients. At December 31, 2018, Ward had accounts
receivable of P 40,000. At December 31,2019, Ward had accounts receivable of P60,000, and unearned fees
of P5,000. On an accrual basis, what was Ward's service revenue for 2019?

Solution:
Cash Collection P200,000
A/R, beg. (P40,000)
A/R, end. P 60,000
Unearned Fees, end (P 5,000)
 Formulas under accrual method:
  Computations under accrual basis:

PROBLEMS:
1. Ward, a consultant, keeps her accounting records on a cash basis. During 2010, Ward collected P200,000
in fees from clients. At December 31, 2009, Ward had accounts receivable of P40,000. At December 31,
2010, Ward had accounts receivable of P60,000, and unearned fees of P5,000. On an accrual basis, what was
Ward's service revenue for 2010?
2. On February 1, 2011, Tory began a service proprietorship with an initial cash investment of P2,000. The
proprietorship provided P5,000 of services in February and received full payment in March. The
proprietorship incurred expenses of P3,000 in February, which were paid in April. During March, Tory drew
P1,000 against the capital account. In the proprietorship's financial statements for the two months ended
March 31, 2011, prepared under the cash basis method of accounting, what amount should be reported as
capital?
3. An entity had the following beginning and ending balances in prepaid expenses and accrued liabilities for
the current year:

Prepaid expenses