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Michael Becker
Michael Becker, Financial Analyst
Category: Finance
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Experience:  Investment Banking
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Calculate the first years net invome cash / accrual basis

Customer Question

In its first year of operations, Harden Co. earned $39,000 in revenues and received $33,000 cash from
these customers. The company incurred expenses of $22,500 but had not paid $2,250 of them at yearend.
Harden also prepaid $3,750 cash for expenses that would be incurred the next year. Calculate
the first year’s net income under both the cash basis and the accrual basis of accounting
Submitted: 10 years ago.
Category: Finance
Customer: replied 10 years ago.
Relist: No answer yet.
I am confused on the what they are looking for in the question
Expert:  Michael Becker replied 10 years ago.

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).

Please let me know if you have any additional questions.