Accrued vs Cash Accounting

Question 1

When cash accounting understates income

Answer 1

he cash basis of accounting, as compared to accrual-basis accounting, will understate income when accrued expenses decrease because that decrease must have been the result of paying out more cash than expenses incurred. A decrease in accounts receivable would have the opposite effect. This decrease would occur as more cash was collected than sales made, producing a higher cash basis income.

In summary, cash basis income is:

higher when accounts receivable decrease.
lower when accrued expenses decrease.

Question 2

To convert cash to accrual example

Answer 2

Accrual-basis net income is computed as follows:

                   Beginning                        Effect on 
                    of Year      End of Year   Accrual Net Income
                   ---------    -----------    ------------------ Cash-basis net income                                   $70,000 Accounts payable        $ 3,000       $  1,000            2,000 Unearned revenue            300            500             -200 Wages payable               300            400             -100 Prepaid rent              1,200          1,500              300 Accounts receivable       1,400            600             -800
                                                    ------- Accrual net income