Todd operates a business using the cash basis of accounting. At the end of last year, Todd was granted permission to switch his sales on account to the accrual method. Last year, Todd made $423,500 of sales on account, and $65,400 was uncollected at the end of the year. What is Todd's §481 adjustment for this year?

Question

Quizplus · Accepted Answer

Since Todd switched from the cash basis to the accrual method, he needs to make a &sect;481 adjustment to account for the difference between the two methods.

On the cash basis, Todd would only recognize sales when he receives payment. So, the $423,500 sales on account would not have been recognized on the cash basis.

On the accrual basis, Todd would recognize the sales when they are earned (i.e. when goods are shipped or services are provided), regardless of when he receives payment. So, he needs to make an adjustment for the $423,500 of sales that were not recognized on the cash basis.

However, he also needs to account for the $65,400 of uncollected sales at the end of the year. Since he did not receive payment for these sales, he would have already deducted the associated cost of goods sold (or expenses for services provided) on the cash basis.

To account for this, he needs to increase his expenses by the $65,400 of uncollected sales on the accrual basis.

So, Todd's total &sect;481 adjustment for this year would be to increase income by $423,500 and increase expenses by $65,400. This results in a net increase to income of $358,100.

Therefore, the best choice is B, to increase income by $16,350, which is the result of the calculation: ($423,500 - $65,400) / 10 (the number of years Todd will spread the adjustment over) = $35,110 adjustment for this year.

Todd Operates a Business Using the Cash Basis of Accounting