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Accrual accounting measures the performance of a company by recognizing economic events regardless of when cash transactions occur. The general idea is that all revenues are matched with their corresponding expenses (the matching principle) and it does not matter when actual cash payments are made or received. Under the cash basis of accounting, an event is recognized when a cash inflow or outflow occurs.
Therefore, under accrual basis of accounting:
Net Income [Accrual basis] = Revenues ($39,000) - Expenses ($22,500) = $16,500. (On its income statement Harden recorded $39,000 in revenues and $22,500 in expenses, so the net profit was $16,500).
Under the cash basis of accounting:
Net Income [Cash basis] = Cash inflows - Cash outflows = $33,000 - ($22,500 - $2,250) - $3,750 = $9,000. (Harden received $33,000 in cash from its customers. Even though the total expenses were $22,500, the firm only paid $20,250 and still owes $2,250 to its suppliers. Finally, Harden paid $3,750 for an expense that will be incurred next year).
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